What’s Wrong with the World

Writing in Vanity Fair and alternating between brilliance and fatuity, Michael Lewis examines one of the detonation zones of the Great Usury Crisis: Iceland. The essay is illuminating in many ways. Lewis certainly understands the culture and psychology of high finance, and he depicts the unique character of the Icelandic people pretty well for so breezy a report. The result is a great read, but of the sort you have to be very careful about, lest you lose sight of the author's lacunae.

One such is this extraordinary statement: "A nation so tiny and homogeneous that everyone in it knows pretty much everyone else is so fundamentally different from what one thinks of when one hears the word 'nation' that it almost requires a new classification. Really, it’s less a nation than one big extended family." Perhaps Lewis has forgotten that "one big extended family" is precisely the definition of nation we get from, for instance, the Old Testament -- and indeed, from antiquity in general. Even the early moderns thought of nations in much smaller, more concentrated terms. A bracing example of a great modern thinker whose theory rested upon smallness in nationality is Rousseau's On the Government of Poland, an unjustly neglected classic. In any case, the true anomaly of nationality, contra Lewis, is a massive, half-imperial polyglot like America.

But my favorite part of the Lewis essay is this:

Iceland’s big change began in the early 1970s, after a couple of years when the fish catch was terrible. The best fishermen returned for a second year in a row without their usual haul of cod and haddock, so the Icelandic government took radical action: they privatized the fish. Each fisherman was assigned a quota, based roughly on his historical catches. If you were a big-time Icelandic fisherman you got this piece of paper that entitled you to, say, 1 percent of the total catch allowed to be pulled from Iceland’s waters that season. Before each season the scientists at the Marine Research Institute would determine the total number of cod or haddock that could be caught without damaging the long-term health of the fish population; from year to year, the numbers of fish you could catch changed. But your percentage of the annual haul was fixed, and this piece of paper entitled you to it in perpetuity.

Even better, if you didn’t want to fish you could sell your quota to someone who did. The quotas thus drifted into the hands of the people to whom they were of the greatest value, the best fishermen, who could extract the fish from the sea with maximum efficiency. You could also take your quota to the bank and borrow against it, and the bank had no trouble assigning a dollar value to your share of the cod pulled, without competition, from the richest cod-fishing grounds on earth. The fish had not only been privatized, they had been securitized.

If you can securitize real estate, why not fish?

(Guest Post)

You understand, venerable brethren, that We speak of that sect of men who, under various and almost barbarous names, are called socialists, communists, or nihilists, and who, spread over all the world, and bound together by the closest ties in a wicked confederacy, no longer seek the shelter of secret meetings, but, openly and boldly marching forth in the light of day, strive to bring to a head what they have long been planning - the overthrow of all civil society whatsoever.

Surely these are they who, as the sacred Scriptures testify, "Defile the flesh, despise dominion and blaspheme majesty." They leave nothing untouched or whole which by both human and divine laws has been wisely decreed for the health and beauty of life. They refuse obedience to the higher powers, to whom, according to the admonition of the Apostle, every soul ought to be subject, and who derive the right of governing from God; and they proclaim the absolute equality of all men in rights and duties. They debase the natural union of man and woman, which is held sacred even among barbarous peoples; and its bond, by which the family is chiefly held together, they weaken, or even deliver up to lust. Lured, in fine, by the greed of present goods, which is "the root of all evils, which some coveting have erred from the faith," they assail the right of property sanctioned by natural law; and by a scheme of horrible wickedness, while they seem desirous of caring for the needs and satisfying the desires of all men, they strive to seize and hold in common whatever has been acquired either by title of lawful inheritance, or by labor of brain and hands, or by thrift in one's mode of life. ...

For, indeed, although the socialists, stealing the very Gospel itself with a view to deceive more easily the unwary, have been accustomed to distort it so as to suit their own purposes, nevertheless so great is the difference between their depraved teachings and the most pure doctrine of Christ that none greater could exist: "for what participation hath justice with injustice or what fellowship hath light with darkness?" Their habit, as we have intimated, is always to maintain that nature has made all men equal, and that, therefore, neither honor nor respect is due to majesty, nor obedience to laws, unless, perhaps, to those sanctioned by their own good pleasure. But, on the contrary, in accordance with the teachings of the Gospel, the equality of men consists in this: that all, having inherited the same nature, are called to the same most high dignity of the sons of God, and that, as one and the same end is set before all, each one is to be judged by the same law and will receive punishment or reward according to his deserts. The inequality of rights and of power proceeds from the very Author of nature, "from whom all paternity in heaven and earth is named."

(Cross-posted)

I've suggested in a number of places that it is possible - I am not committed to it being definitely true - that much of the circulation of abstracted risk which led up to the current crisis took the form of something like a horizontal Ponzi scheme. It is horizontal because it involves circulation of abstracted risk among peers, and it is like a Ponzi scheme because it involves selling something which doesn't exist. We know that Aquinas thought charging interest on a loan was usury, and therefore morally wrong, precisely because he believed that it involved selling what does not exist.

All that discursive abstractness isn't everyone's cup of tea. But if you can just imagine the Escher waterfall lined with investment bankers, lenders, homeowners, and who knows who else all dipping in their goblets for a nice deep drink, I think you'll get the basic picture.

Although published during the 2008 presidential campaign, Michael Bauman's essay on government bailouts is probably more relevant now than it was then. Mike, as some of you know, is a frequent commentator to WWWtW. Here are some excerpts:

Paul Cella's post Biblical Solutions is especially timely not just in light of the current recession, but also because of the publication of Pope Benedict XVI's new encyclical Caritas in Veritate. I'll have more to say about CV once I've read the whole thing. In the meantime, it would be useful to issue a little primer about how Catholic social teaching applies in today's dire circumstances.

What I've seen of CV so far is quite in line with how Catholic social teaching (see here for its official "compendium") has been developing since Leo XIII's Rerum Novarum (1891). By endorsing private property and the pursuit of profit, it is compatible with some forms of capitalism and thus needs no defense around here. But it also insists on conditioning those goods by such principles as "the universal destination of goods," "solidarity," "subsidiarity," and "the preferential option for the poor." As moral injunctions for the faithful, those principles are not terribly controversial either, at least among Christians. Most of the debate about applying Church social teaching concerns the extent to which such conditioning principles call for civil legislation and regulation, especially concerning the economy. On that question, the political (and theological) Left is generally maximalist; the political (and theological) Right is generally minimalist.

As a conservative in the American sense of the term, I come down mostly with the minimalists. Thus I believe that the principle of "subsidiarity" calls for private over public solutions when the former are feasible. From a theological standpoint, though, the question whether to be a political minimalist or a political maximalist is a matter of prudential judgment, rather than doctrine, about what's "feasible." The question is essentially empirical, and boils down to how to balance, in practice, the principle of subsidiarity with the other principles "conditioning" the goods of private property and profit. Subsidiarity is generally more popular with the Right than with the Left. But for Catholics, and a fortiori everybody else, Rome generally treats the balancing act as a matter of opinion. For the social teaching of the Church is logically compatible with a rather broad range of prudential judgments about how to implement it in the concrete.

In fact, what conservative critics of the Church's social teaching often fail to realize is that, seen as a whole, it is less palatable to the Left than to the Right. Liberal Catholics generally embrace Church teachings on, e.g., the death penalty, health care, and the treatment of immigrants, and want them enshrined in secular legislation; but on abortion, euthanasia, same-sex "marriage," and other issues called "social" in American political parlance, the song changes dramatically. True, the precise converse holds among many Catholics who are politically conservative, especially in the U.S.; but in my view, the conservatives hold the theologically stronger position. As Fr. Robert Sirico of the Acton Institute notes:

It is quite a spectacle to see Catholic progressives — who in other circumstances contort themselves into exegetical pretzels when they want to undermine clear, emphatic, authoritative, and repeated magisterial prohibitions on same-sex relations, female “priests,” and contraceptive acts — morph into virtual Ultramontanists on prudential matters such as the precise level of a minimum wage.

And the same could be said, mutatis mutandis, about many other political issues, such as whether the advantages of government-run health care would outweigh the disadvantages. As I argued in this post, the trouble with the Catholic Left is that it often presents as morally binding certain political proposals which, from Rome's standpoint, are really matters of opinion, and presents as matters of opinion certain political proposals which, again from Rome's standpoint, are morally binding. So not only is the Catholic Right's general sense about Church social teaching theologically sounder than the Left's; said teaching is more easily reconciled with American "conservatism," or at least with some strains thereof, then with American "liberalism."

But in some cases, applying the Left/Right dichotomy is simply unilluminating. The "usury crisis" Paul has described is a good example. Although people can debate from now till doomsday how much state regulation of debt instruments is wise, and probably will, it cannot be denied either (a) that some degree of regulation is necessary, and (b) that the explosion of public and private debt, all slated to be repaid with interest, has been bad for everybody. Ignoring the traditional moral strictures of the Church about debt and interest fosters a systemic greed which is eventually self-defeating. We are now in a situation where bankrupt governments are shoring up bankrupt sectors of the economy with funny money that will burden the next generation and beyond with unsustainable debt service. That wouldn't have been necessary if both the private and public sectors hadn't reduced themselves to pigs feeding at the trough. Because both private and public greed have driven this crisis, it's really not a Left/Right issue. It's a rather elementary moral issue.

The comment thread under my original post has broached a variety of subjects, and touched upon many implications, actual, potential, or imagined, following from the arguments sketched therein. Rather than attempt to respond to each one these in the original thread, leaving the matter of the responses' connections to the original queries ambiguous - who raised this issue?, to what is this a response? - and thus cluttering up the thread, I thought it preferable to group them together in a new thread, where they might better be clarified.

The question of nature of the currency, and of its backing, has arisen. It is beyond all caviling that the monetary policies of the Greenspan Fed provided a crucial material cause for the development of the financial bubble, and thus, the subsequent collapse. The broad recognition of this reality has precipitated a renewed interest, if only on the right, in the gold standard particularly, and perhaps also in more complicated currency systems backed by a combination of precious metals. I'm not entirely unsympathetic to the interest, but though I am unreservedly critical of the role of monetary policy in the generation of the crisis - and of the attendant manipulations of fundamental economic data concerning inflation and unemployment - it does not appear to me that the gold standard, or any other hypothetical metallic-based currency system, suffices either to preclude the ruinous cycles of boom and bust characteristic of modern capitalistic economies, or to preclude the possibility of deleterious consequences proceeding directly from the monetary system itself. The historical record of the gold standard in the nineteenth century was rather dismal, if one is concerned to have some sort of monetary prophylaxis against cycles of bubble and bust. Moreover, the relative fixity of the quantity of currency under a metallic standard renders rather difficult the entrepreneurial function, inasmuch as, if one posits a relatively static money supply and and expanding cycle of trade - which the entrepreneur must - then it follows that prices must decline as the economy expands. This is, to say the least, a confusing sort of economic signaling; few entrepreneurs will be willing to invest in the expectation of.... falling revenues, profits, and income. Now, of course, businesses were routinely started under the gold standard, but that merely leads into the second difficulty engendered by the relative fixity of the monetary base under a metallic standard. If the supply of money is static, or relatively fixed, in the sense that it expands slowly and fitfully, with new discoveries of specie, or new acquisitions by a central bank, and the economy is assumed to expand for a time, then it follows of necessity that the relative value of existing debts increases, and that this increase is highly correlated with falling prices. Apologetics for the gold standard often emphasize this latter aspect of the system, and, in my estimation, practice a bit of evasion with regard to the former, for it is the former aspect that proved to be the achilles' heel of the system in operation, as the periods of expansion would result in the appreciation of existing debts, a process which sooner or later become utterly unsustainable. This intrinsic feature of the gold standard served as a contributing material cause of the political ferment of the late nineteenth century, particularly among farmers, who found the real value of their debts appreciating more or less simultaneously with the collapse of agricultural commodity prices. Bankrupted by debts impossible to discharge, their properties would be foreclosed upon - and this raises the final, insuperable problem with the gold standard: it is regressively redistributive, effectively, over the cycle of expansion and contraction, redistributing wealth - often real and tangible, as opposed to merely notional - from its possessors, often smallholders and small businessmen, to those who had the good fortune to possess capital to lend at t1. Given that one of the preconditions of our present financial crisis was, shall we say, an insufficiency of resources among the broad middle of the economic spectrum, owing to politico-economic trends of the past two generations, and given, moreover, that any durable solution to our economic predicament must result - at least in the medium term and beyond - in both a rising median income and greater income stability among the middle classes, a monetary system which features regressive redistribution is a non-starter.

One of the real problems we face is confusion about the interaction between economics and philosophy. Men are seen constantly arguing across a chasm of pedagogic division, with one shouting fiercely about certain principles of nature and man qua man, and another gesturing sharply toward the empirics of a science. The fact-value distinction has left some of us unable to communicate.

Megan McArdle wrestles with some of the same difficulties in this essay on the statistical history of Gross Domestic Product.

I propose that we need to repose in that discipline or field of study which proposes to bridge this divide; which proposes to make some balance or unity of facts and values. I mean, the field of politike episteme, a Greek phrase which translates directly to political science but (following Voegelin) I would say more closely resembles what we call political philosophy.

Consider this exchange:

“Efficient-markets theory says only that markets will give us the best estimate of value. Price is our best estimate of factual value. So on the evidence, all of our banks should have perished in 2008. They were ruined institutions. If I, as trader in bank-related credit derivatives, could have had my view made policy, all of your nationalization wishes could have come true. The banks were dead. We derivatives traders glimpsed it first. Policy should have reflected it. So why should I be blamed for a political system that won't let banks fail?”

“Any derivatives trader, by virtue of his labor activity, is complicit in the very trade which brought down the banks; all of which is to state that a derivatives trader creates the conditions of his own claims to knowledge, much like oil speculators in 2008 driving up the price of oil, after real estate tanked, and then claiming that the increased ‘demand’ for oil made it a great investment. One doesn't get to create one's own knowledge and then claim an especial prescience for ‘knowing’ it, or teasing out the implications of it. The implications of the derivatives trade were that the big Wall Street banks were insolvent, and ought to have been liquidated by the Feds; the derivatives trade caused this, more than any other factor. Moreover, the derivatives trade was not a necessary condition of this knowledge; one doesn't need a trade in occult financial instruments to know whether banks are insolvent or not; one needs only the information that banks have been required to disclose, even before derivatives emerged as a critical orgy site for Wall Street.”

Here is an argument which combines factual claims with philosophic principle. The speakers refer to facts and propose principles for weighing and interpreting said facts, with an eye toward applicable policy.

It is a distinct temptation to concentrate one’s attention, and therefore one’s censure, on the intrigues of Wall Street. And often mere intrigues are what they are. I am have been perusing a handful of books by business and finance journalists, which among other virtues provide the reader with some picture of the human personalities behind the boom and busts of high-finance engineering. For instance, there seems to have been a very clear personal rivalry, an archetypal clash of masculine ambition, concomitant with the rise of the mortgage-backed bond market. The very invention and early development of this new trade in debt securities confected out of hundreds of mortgages, tracked rather neatly for some years, starting in the early 1980s, with the competitive enmity between Laurence Fink and Lewis Ranieri, of First Boston and Salomon Brothers, respectively.

The portrait that emerges from stories like this is that ritual denunciations of “greed” can easily blind us to the deeper motivations of the men who built up the infrastructure of usurious finance. Simple avarice, the desire for material gain or possession, is only one aspect of the libido dominandi.

This Bloomberg report on the financial crisis at Harvard University last year is worth reading, even if you just breeze through all the technical talk about interest rate swaps.

There is, first, the almost epic poetry of this fact: that a big player on seemingly every side of this web of contract and abstraction and folly… is a Harvard man!

In the midst of the crisis that triggered this Great Recession, Harvard University suddenly faced a crisis of its own. The University owed a Harvard man’s company (a fragment of the old Morgan empire), along with other banks, huge sums in collateral calls. It had sought to trim its capital costs with purchases of interest-rate and forward swaps. The degraded swaps went precipitously illiquid last fall, and far from lowering the school’s capital costs, instead opened a gaping hole in its available capital. “Harvard was so strapped for cash,” according to the Bloomberg report, “that it asked Massachusetts for fast-track approval to borrow $2.5 billion.”

The University survived, but its endowment fund lost close to $10 billion. A big chunk of the cash collateral went to JPMorgan Chase & Co., a firm whose history intertwines with the august Cambridge institution. (J. P. Morgan, Sr., himself had bequeathed to Harvard Medical School $1 million in 1901.)

And one of the men from the Government hired to clean up the crisis that wounded Harvard and most of American high finance — well he used to be the President of Harvard when the school purchased the toxic swaps, and indeed, he answers to a President who graduated from Harvard Law School. Many of the deputy financiers in this story also have Harvard ties.

Writing in the latest number of National Affairs, Eric Cohen ably memorializes the “moral realism” of the late Irving Kristol, greatest of the neoconservatives. Cohen’s focus for most of the essay is Kristol’s searching examination of capitalism, which featured prominently through his entire career as a writer and editor. Never let it be said that Kristol was an uncritical promoter of the capitalist form of political economy. Cohen quotes at length from a speech in 1991, when capitalism was at its very zenith of prestige:

In a sense, it is all Adam Smith’s fault. That amiable, decent genius simply could not imagine a world in which traditional moral certainties could be effectively challenged and repudiated. Bourgeois society is his legacy, for good and ill. For good, in that it has produced through the market economy a world prosperous beyond all previous imaginings — even socialist imaginings. For ill, in that this world, with every passing decade, has become ever more spiritually impoverished. That war on poverty is the great unfinished task before us. The collapse of socialism, along with the vindication of a market economy, offers us a wonderful opportunity to think seriously about such an enterprise. Only such an enterprise can ensure a capitalist future.

Cohen recapitulates this point repeatedly, and with increasing insistence: “in the end, as Kristol argued, our destiny will depend far more on our cultural and spiritual lives than on our regulatory and tax policies.” “Building a family requires precisely the virtues and spiritual purpose that the capitalist order fails to nourish, while the future of the capitalist order — and, more significantly, the future of a morally decent, democratic, and prosperous modern civilization — requires flourishing families.” “Perhaps the most important work before us — which Kristol, a Jew in largely Christian America, could not do — is to reform and re-invigorate Christian political theology, for it is on this that the spiritual vitality and moral-political sanity of American civilization likely now depends, both for better and for worse.”

Well worth a read.

UPDATE: By the strange twists of memory, the mystic chords even, I am reminded of this fine essay by Cohen, which had a dramatic effect on me almost ten years ago.

Is there a useful distinction between Capitalism and Free Enterprise? I am convinced that the answer to that is an emphatic yes; and that the distinction is vital to a proper understanding of the wreck of our political economy.

Free enterprise is characterized, above all, by a wide private field for business competition and innovation, operating under a structure of laws analogous to a good referee in a ball game. Savers, under free enterprise, extend their capital to the successful enterprisers in the community. The economy is not isolated — some of its magnates aspire to national or even world prominence — but its core is local or regional. Its health is the effective and trustworthy lending of the capital of the older folks of the community, who have savings, to the industrious and virtuous of the younger businessmen. The old generation earns a return on this lent capital; and the younger businessmen are able, when successful, to build and distribute new wealth.

There is definitely risk in the system, but it is risk faced primarily on a personal level. Risk is intimately linked to trust. The man of means wants to know the men he invests his capital in. He'll ask about their families. He'll do his homework, but often he’ll have to take his risks based on his gut sense about men.

The great seaports of New England in colonial and early Republican America are exemplars of the free enterprise system. It is manifest that remarkable risk was undertaken in the whaling trade, when ships and stores and whalers were out to sea for a year and more, or any of the other thousand seafaring enterprises the New Englanders developed to generate their wealth. It is manifest that the trade by which this wealth was generated was a global operation. But the core of the capital at back of it was anchored in the integrity and independence of the New England towns.

With regard to particular assets — say, mortgage securities or Italian bonds — each bank knew only its own exposure to Long-Term [Capital Management]. Goldman Sachs had no idea that Salomon might be financing a similar trade; J. P. Morgan would not have known that Merrill Lynch was duplicating Morgan’s loans. So in theory, each bank had no notion of how big Long-Term was in any particular trade. But in practice, the banks were in a good position to estimate. The world of bond arbitrage is relatively small. Certainly the banks knew enough to ask for more specific disclosures. And of course they could have declined to do business with Long-Term if satisfactory answers were not forthcoming.

But the banks were fighting to do more hedge fund business, not less. Five years into a bull market, the banks were awash in liquidity, and the hedge fund trade was a lucrative way for Wall Street to employ its surplus capital. The banks accomplished this by a practice known as “renting out the balance sheet” — literally, transferring their enormous borrowing power to hedge funds with lesser credit ratings,* a service for which they charged mere pennies on every $100 of credit. Long-Term, which was easily the Street’s biggest hedge fund customer, was reputed to be throwing off $100 million to $200 million in fees to Wall Street each year, and each of the banks wanted as big a share of the money as possible.

That’s from When Genius Failed, Roger Lowenstein’s very highly-regarded story of the rise and fall of the hedge fund Long-Term Capital Management. What was Long-Term’s business? Well, it carried out investments according to the vision of John Meriwether and his band of academics and traders, who brought to Wall Street in force the analytical subtlety and brilliance of advanced mathematics, wed it to modern computing power, and produced a dazzling new field of “financial technology.” They used their mathematical tools to identify tiny fractional irrationalities in bond markets, and then piled up enormous capital behind their bets through huge leverage.

Into this business banks and other financial institutions poured their surplus capital through most of the 1990s. It continues to this day. “High-frequency trading” and “dark pools of liquidity” the latest terms for this arbitrage of the infinitesimal.

It can be a real challenge to penetrate the cloud of cant and catchphrase that envelopes the discussion of the financial crisis. How profoundly this disarray has shaken American institutions is still far from evident to the great majority of people. Thus the allure of the conventional, that pattern of soothing slogans and bromides, which lulls the active mind to sleep, is very strong.

It is therefore always welcome to read fresh, creative analysis, of which the following two articles are exemplars.

First is Francis Cianfrocca’s assessment of China as “the world’s most Keynesian state.” He explains why this is so quite vividly; which in turn helps explain, perhaps, why commentators from Tom Friedman to Bono to the French Foreign Minister have recently given voice to their admiration for Chinese efficaciousness. For all of my adult life, an assumption undergirding the vision of Globalization was that Chinese openness to private enterprise and growth economics would eventually issue in openness to political freedom. In a word, capitalism would inexorably push that country toward liberty. Now it looks more and more as though the reverse may be true. Chinese capitalism, with its distinctly authoritarian bent, appeals to statists everywhere. They look at China and see a neat arrangement where private businesses answer meekly to the dictates of state policy, which includes an impressive range for profit and growth, thus placating the business class while maintaining the despotic structure of the state. The charm of this arrangement to, let us say, an enthusiast of green technology, or a politician in favor of socialized medicine, or indeed anyone sympathetic to what used to be called “industrial policy,” is no mystery.

Second, this column by Anatole Kaletsky in the (UK) Times is a fascinating read. If he’s right, it adds an intriguing new twist to my suspicion that it was a bad idea to allow the investment banks to become public corporations by issuing common stock. Kaletsky is not above a little creative mischief; he characterizes this development in banking in explicitly Marxian terms. Well worth a read.