The Only Escape from this Trap is Failure
Market Delusions
It’s alright to stay: I’m not going to stir the ashes of the financial collapse. I have bigger fish to fry, so I’ll just do a quick resume of the situation from my viewpoint, then get to what’s on my mind; namely, what sort of trap did we all fall into in order to create such a calamity? More importantly, was the collapse actually a typical intractable situation that slowly becomes a crisis?
OK, the government did it. There, I’ve said it, so you don’t have to get feverish trying to anticipate who I’m going to blame. Just my opinion. I’m a simple man who likes to think of causation occuring in some sort of sequence. Cause and effect; one foot in front of the other. So I can’t blame organizational size, or derivatives, CDO’S, CDS’s, short sales, speculators, greedy bankers, cowboy traders, quants, or anything else appurtenant to the financial industry. The industry is as we found it in late 2007 – gigantic, dynamic, prosperous; powering a worldwide market with trillions of transactions each business day.
But a massive worldwide distribution system is only as good as what it distributes. Until the crisis, it was good credit paper that fueled millions of jobs, protected nest eggs, liquified businesses large and small. Feed garbage into this behemoth and that’s what you distribute. Republican and Democratic governments had a hand in pressuring banks and incentivizing mortgage brokers to drop prudent underwriting standards; both were allowed to bundle the mortgages and ship them off to the behemoth. They made lots of money, the government got money and votes, and the behemoth had a feeding frenzy at a time when it was important to have a product to sell to world investors hungry for a return.
The rest is a history that will be interpreted in many ways – already has – and we all agree we had a close call. So here’s what’s bothering me: How is it that virtually every cadre of our professional world failed to stop this before it went off the rails? It’s not that we didn’t have regulators; the various congressional committees are trying to eliminate the stovepiping of responsibility, the venue-shopping by financiers, and the many authority overlaps among agencies.
The rating agencies were there, churning out ratings at an accelerated pace, assuring investors they were buying good paper (it’s interesting to note that the subprime loans were rated AAA because that was the best rating for that type of loan. It wasn’t until 2008 that the agencies woke up and realized this sent entirely the wrong message to the markets, and they proceeded to change the ratings on all future mortgages). The banks, large and small, had regulators sitting next to them at work. The stockbrokers and bond traders and insurance investors were all tightly regulated as a prerequisite to being in those businesses. Fannie Mae and Freddie Mac were the massive guarantors of these packaged mortgages, answering both to the executive branch of the government and their public shareholders. The mortgage brokers were the least regulated, but dependent for their business on the good will of their communities and those who purchased their mortgages.
So, back to the top: What really caused all of these actors to avoid acting to save their own system? It looks like some kind of delusion trap wherein the momentum to profit caused a loss of restraint and reached a tipping point where no one within the system would have been powerful enough to stand up and say “stop” without being disregarded, disgraced or dismissed. Self-interest, at every level, in a consensus environment, forces everyone to keep the game going until it collapses of its own internal contradictions.
If that’s so – and I’m only speculating – what other delusion traps do we know about where all the actors are trapped in a paradigm that will eventually fail, but not before causing a lot of external damage? I nominate prohibition, campaign finance and the federal income tax. The immigration mess is a poster child for what happens when you refuse to deal with a daunting, controversial problem involving a lot of self-interested constituencies, here and abroad. I’m sure you can think of a lot on your own, so feel free to pile on with your suggestions. This is important, because it happens these are intractable problems with global significance.
There are now too many constituencies benefiting from the drug war to allow anyone, for any reason, to change it. No one thinks the income tax is anything but a disaster, and there are many good alternatives, but we are paralyzed into riding the current system right over a cliff. Congress is trapped into spending a significant part of their lives fund raising, rather than governing – a widely known fact – and they desperately need tax money to fund programs to curry favor with voters. This produces a lot of bad outcomes, but no one who can change it will, because the status quo is what they mastered in order to get their jobs. Do we need the entire government to fail before anything gets fixed? Is it necessary to just scrap our constitution and start over? I’m afraid we’re going to find out.
Which brings us to:
FREQUENTLY UNASKED QUESTIONS
- Re Fannie, et al: How healthy is it to have a government entity with private shareholders who can lobby Congress and make campaign contributions?
- What will prevent future regulatory defeasance if the regulators aren’t sure their decisions will be supported and insisted upon by their elected leaders?
- How is it possible for voters to rescue officials from their own delusion trap if the trap makes the rescue impossible?
- Is there a level of buy-in to certain human activities that only a calamitous collapse can resolve?
- Why do we keep electing officials who wilfully profit off the delusions of others?
- After all the hearings, will Fannie and Freddie get ‘fixed’ ?
- Will mortgage-loan underwriting standards get restored?
- Which regulators allowed those standards to be removed?
- Which legislators approved of the regulators defeasance?
- Is Wall Street ‘greed’ the same as, or worse than, politician’s ‘greed?’
- How can we defend against recurrences if we allow blame/causation to be deliberately misdirected?
