What Needs To Go Right

The debts will not be paid

2012-01-02T09:17:00.002-05:00

The debts will not be paid. Not the sovereign debts, the corporate debts, the municipal debts or the personal debts.

This is not a question of moral hazard nor is it a slogan on a piece of cardboard or line out of an Internet manifesto. It is simply a systemic reality. It is not possible to “balance the budget” by reducing the quality of life. There are not enough teachers, firemen and police officers to fire. There are not enough government agencies to close.

We cannot solve this problem through deprivation. Aside from the human misery, the math doesn’t work. Certainly we can create a balance sheet that makes it look like we can get to a zero debt position but the problem is that our currency is based on debt. When we put people out of work they can’t pay their own debts or their taxes. That puts more pressure on a system that is already in collapse.

But there are many sources that analyze the decline of debt based monetary systems; that’s not the purpose here. The underlying question that we need to begin to address is the purpose of money.

Many of us still believe that we can put our money “to work”. We have 401k’s. We have investment portfolios. We buy gold and silver. We want to see the value of those accounts go up.

Money doesn’t “work”. Originally it was an abstract concept created to allow a more efficient exchange between human beings. This idea that you can make money from money has been derived essentially from the concept of gambling – something for nothing. But what has been deceiving about our accounting standards and financial markets is the fantasy behind it all. This money does not only not “work”, it doesn’t really exist. It can disappear in an instant.

Here’s what’s interesting. What we are discovering is that the exchange between human beings seems to rely less and less on this abstract concept.

We exchange all sorts of ideas without the involvement of money. There are many websites, perhaps the one that you are reading this on, that provide information without charging money. We can download operating systems and applications without the use of money. The use of those tools can add tremendous value to the lives of those who use them. The exchange seems to be based on the desire to share and the need to make a contribution. For some time the business community has viewed the individuals who develop these tools and share them without the use of money as whack jobs who just don’t understand how economic systems work. It’s beginning to dawn on some of us that it may be the other way around.

A world without money seems like lunacy. But we need to become more aware that money is really an idea and that its utility is based on a belief system. Belief systems do not change over night but they can shift quickly. Often ideas that still can be useful are subsumed into larger ideas – much like the understanding of gravity in Newtonian physics is subsumed under the idea of entanglement in Quantum physics. So one way to think about this issue is that money will not go away completely, it will just become increasingly less relevant.

One of the first steps in the transition toward a more sane process for human beings to exchange goods, services and creativity is to understand the futility of our current system. But it’s important to get past being right about what is going wrong. The next step is to take a chance, perhaps fail and then take another chance.

The Certainty of Uncertainty

2011-12-12T08:13:00.000-05:00

Over the past year we have heard intermittent calls for the restoration of confidence, usually by those who would relax all manner of regulation and oversight of commercial and financial ventures. The past, it would seem, adds credibility to their argument. Regulation in the financial markets and the internal financial operations of publically held companies has done absolutely nothing to prevent the ongoing crisis that we find ourselves in.

But this clamor for confidence tells us that despite all the calculations, projections and efforts by central banks to keep the flow of money moving it all comes down to how we feel. If we felt confident, we are told, then we would behave differently. The pathway to that better feeling varies from deficit spending to balanced budgets with the advocates of either position passionate about the correctness of their remedy.

But no matter what we do our feelings are only buoyed for a few days and then they once again sink. We feel uncertain that we were right to feel better.

There are many analogies to this situation; Einstein’s definition of insanity comes to mind. Another would be the problem of transitioning from a moral society in which we apply a known set of rules to every situation to an ethical one where we begin to understand that solutions are intuitive and not measured solely by numbers on a balance sheet.

We are discovering that our set of rules is no longer relevant to the problem. Laurie Hyland, in a set of papers that can be found at www.thenewmoneyreality.com provides us with a pathway to understand the new context that we are all living in, regardless of whether we choose to acknowledge it. The following example is borrowed from her work although its application may be of my own interpretation.

Take a bowl and let a marble slide down its side. Eventually the marble comes to rest. In classic physics we say that the marble has reached equilibrium. In classic economic terms this is equivalent to the certainty that we allegedly crave. Now take the same bowl and fill it with fruit suspended in Jell-O. If you take a fork and attempt to remove one of the pieces of fruit, everything moves. In Quantum physics that’s called entanglement. In what Hyland calls Quantum economics that’s Lehman Brothers. The idea of “we are all connected” has transitioned from an esoteric mystical concept to an increasingly robust scientific theory to an economic reality.

It would almost seem that the current efforts for budgetary unity in the Eurozone would reflect this new reality but I would suggest that in fact it is a continuation of attempting to apply a moralistic set of rules to an ethical challenge. Economics is a discipline devoted to understanding how we relate to each other, what it is that we think has value and how we interact with each other to enhance the human experience. Tragic as it may appear to those who have elevated the left brain to the highest form of human endeavor the rational mind is not up to the current task. Kahneman and Tversky’s Prospect Theory has been telling us for some time that the rational mind does not determine how we behave; Taleb’s Black Swan tells us that the rational mind is really only useful in describing retrospectively what has caught us completely by surprise. Our insistence on stability he says simply creates greater instability.

So, let us begin to expand this new thinking. We will find much ridicule and certainly some blind alleys but that experience will serve to refine the new approach. Ultimately it is and will be much more satisfying than trying to convince ourselves that there is such a thing called certainty.

Truth in America

2011-01-26T13:19:00.000-05:00

Truth is an emotion applied to a set of facts. President Obama stated early in his State of the Union speech:

“Two years after the worst recession most of us have ever known, the stock market has come roaring back. Corporate profits are up. The economy is growing again”.

He went on to lament the current state of unemployment and the economic pain that many Americans are suffering. It is hard to reconcile the two statements. If the economy is growing and profits are up then why the pain? Consider the following:

· The Federal Reserve is printing $75 billion a month in its ongoing QE2 effort.

· The latest housing report tells us that we will have more foreclosures in 2011 than we did in 2010.

· There are reports that states are exploring the legality of bankruptcy as an avenue to void public employee pension obligations.

We could apply a truth to that set of facts and come to a completely different conclusion about whether or not the recession is over. It is a schizophrenia that affects nearly every public conversation these days – from gun control to the national debt. Pick your set of facts and you will have a truth that others will insist is a lie. Some would say that that is standard operating procedure for our political process.

But I would suggest that there is a different dynamic emerging that separates our current situation from the economic and political cycles of the recent past. The truths that we are being presented with have been recycled to the point where they are ossified. Positions are hardened. Despite the tremor of Tucson the best we can realistically expect is a more polite expression of the sentiment that the other guy is dead wrong and will likely burn in hell.

Several months ago David Brooks made the following observation on the PBS News Hour television program. Change, he suggested, sometimes was the result of the actions of leaders and sometimes the result of an attitudinal shift on the part of the people. He felt that we are in a time when the latter idea is in effect and I would agree with him. Things change when people change their minds, when they develop a truth based on a set of facts that come from their own experience rather than the ideas of their leaders.

The recent events in Tunisia would seem to demonstrate this concept. Is this just the replacement of one repressive regime with another? Perhaps, but it would seem that there is a decent chance that we are seeing the kind of shift that occurred in parts of Eastern Europe after the fall of the Soviet Union. For those in the West who see this as a strictly Middle Eastern and North African phenomena I would suggest keeping an eye on the Irish as we move into the spring.

It’s hard to disagree with the goals that President Obama laid out in his State of the Union. Yes, we want our children to have better educations, yes we want a modern infrastructure with bridges that don’t fall down and high speed railroads, yes, we want our energy to come from non-polluting sources (although how natural gas and uranium got into that mix is a mystery) but it’s hard to imagine how we get there from here with a political system that seems devoid of any plan that entails confronting the very substantial problems that face us.

In a way, the political process is a head fake. What we are looking for isn’t going to come from there. What we are looking for will come from innovative thought and action. Some of it will be half-baked and fail, some of it already exists on a small scale and is growing (like local currencies and the move by Washington State to emulate the state bank of North Dakota) and some of it will seem like it is coming out of the blue. The only thing that seems clear is where it won’t come from.

The Risk of War in Korea

2010-12-06T10:52:00.000-05:00

Regardless of your opinion about the existence and intent of Wikileaks perhaps the most surprising thing about the internal diplomatic cables that have been revealed to date is that they are not very surprising. The Karzai brothers are corrupt and/or ineffectual, Ahmadinejad is unstable, Al Qaeda gets significant funding from the Saudis, Syria is still arming Hezbollah and so on. While perhaps no one says these things for public attribution they are reasonably well known to most people who follow foreign affairs and read something other than the official communiqués of sovereign governments.

But there was something new conveyed by a conversation that an American diplomat had with a South Korean diplomat about a conversation he had with a Chinese diplomat. China is said to be supportive of a unified Korea even if it was run by the existing South Korean government with its alliance with the United States. As Americans hear this, their Cold War view of the Korean peninsula takes a big hit. For the last 50 years most Americans think of the DMZ as a dividing line between democracy and communism. This made sense in the days when we all imagined Mao sending the screaming hordes of Chinese and North Koreans to destroy the South. After all, it actually happened once before.

But unlike Mao, Wen Jiabao is more focused on property bubbles and currency fluctuations than spreading the Great Leader’s dogma. Korea has to be a headache. The Kim family, with its obsessive and singular goal of retaining power is a distraction from the very real problems that China must manage as it continues to emerge as a global economic power. The prospect of trading the mercurial (and apparently dying) Kim Jong Il for the 25 year old four star general Kim Jon Un can’t be a very happy one.

So the fact that reunification is being contemplated by the Chinese is news indeed. The last time we all had this experience was in the fall of 1989 when the Berlin Wall was breached. That seemingly spontaneous event was preceded by fits and starts; East Germans were leaving by the thousands initially through Hungary and then through the former Czechoslovakia. The final breach in the Wall resulted from a politburo spokesman adlibbing in a press conference. But all these events were preceded by Reagan’s strategy of economically bleeding the Soviet bloc via the arms race. Spending money they didn’t have on the military and ignoring social needs and physical infrastructure is what brought the communist house down. If that strategy sends a chill down your spine it probably should.

South Korea has just belatedly completed a trade agreement with the United States (just a few weeks after embarrassing President Obama on the world stage at the G20 meeting). We can debate who came out on top in that deal but what can’t be debated is that China has replaced the US as the major trading partner of South Korea. Having kept the peace for over 50 years through diplomacy and the threat of force the United States now finds itself in a situation that is clearly in transition.

North Korea is not East Germany. The fact that they have atomic bombs changes the equation dramatically. More importantly, they have a dynastic family that wants to hold on to power and they seem to have put together a succession plan in a very hasty manner. One has to wonder about the calculation to choose the youngest son – one whose experience would have to be called into question by the coterie of generals and party officials whose survival depends on the absolute authority of the ruler. If the leadership transition happens sooner rather than later the risk of a calamity becomes greater.

There is an expectation that the North Korean regime will unravel slowly over three years after the leadership transition. That would be nice, but unlikely. The demise of totalitarian systems is rarely graceful. Add to that the recent provocation on the part of the North and the ongoing war games on the part of the South and the United States and it certainly begins to feel like a broader conflict is in the works.

But there is also another possibility. When we look at potential conflicts we often limit our observations to the military, political and economic information that is available. We tend to ignore the underlying cultural history and beliefs. That has come back to bite us in Iraq and Afghanistan. It might just be the key to a solution in this situation. Korea is the home of Tae Kwon Do. Most of us believe that the martial arts are about fighting but Tae Kwon Do is as much at art of peace as it is of self-defense. It has to do with loyalty, faith and respect. Will that tradition become more powerful than the drive towards conflict? Will the underlying cultural values of a people trump the push towards war? It will be instructive as we all find out.

Separation of Bank and State

2010-11-28T08:30:00.001-05:00

There is currently a series of commercials on American television promoting an operating system used in many of the new smart phones. In one version of the ad there is a man standing at a urinal, relieving himself using one hand and texting with the other. He drops the phone. As he bends down to pick it up and presumably resume his one handed typing a man a few positions down looks over, wrinkles his brown and says “Really?!”. The message is that we all have better things to do than stare at what comes over our electronic devices. The world full of people is worth our attention. Interesting idea.

Perhaps the most ominous part of Ireland’s proposed austerity plan is the decrease by €1 in the minimum wage. When you first read that number is doesn’t seem so bad – it’s only a 1/one. That’s until you remember that the minimum wage is expressed in compensation per hour. Then the 1/one becomes much larger. It is equivalent to an 11.5% decrease in gross income. Take a moment and think about what a reduction of that amount would mean to you. Think of the conversations that would happen between you and those you care about, between you and those who depend on you.

The somewhat better off, those earning the equivalent of $67,000 would experience a $5,700 reduction in gross income according to John Burn’s article in the New York Times or slightly under 9%. Those conversations don’t seem any more appealing. The Irish are stunned. What happened to the Celtic Tiger? What happened to the economy that for the first time in memory reversed the trend from emigrating elsewhere to returning home to share in the revitalized economy? Is Ireland the same as Greece?

Actually, Ireland is not the same as Greece. The Greek government had a very large Ponzi scheme going on. By all accounts, the Irish government was, from a financial perspective, well run. It is the Irish banks and their disastrous balance sheets that are the source of the problem. The banks made loans and investments that went south and the conventional wisdom is that the government should bail them out. It is similar thinking to what lead to the infamous TARP legislation in the United States.

The problem that we are facing is that the conventional wisdom is looking less wise with every passing day. The first crack in the idea that banks should be bailed out by governments came with the expression “privatizing profits and socializing losses” that began appearing in the media several years ago. In the United States, members of Congress who voted for the TARP funds were ripe targets for those who thought that lending money to failed institutions ran afoul of free market principles.

The western banking system is a private system. The Federal Reserve, the central bank in the United States, is owned by the chartered banks of the United States. The Federal government has no equity stake, no ownership of the Fed. With some nuance, the same situation exists within the European Central Bank and the countries in the EU. It is not just the management of monetary policy that is in private hands (and therefore allegedly immune to political influence); it is the creation of money itself.

That this structure is just now being understood by more and more people is the subject that leads us down all sorts of unpleasant paths. I have friends who are conspiracy theorists. Their views range from the fantastic to the fatalistic. To the degree that they get people interested in what is going on they have a positive influence. To the degree that they convince us that we are victims of forces more powerful than we can conceive they are destructive.

It might make more sense for the central banks to bypass sovereign governments and recapitalize their member banks directly. As a matter of fact, that’s what occurs for the most part anyway. The Federal Reserve has been funneling money into the US banks in amounts that dwarf the TARP funds. But taking that approach would shatter the myth that governments have much of anything to do with monetary systems. The problem in these situations is that the people most invested in the myth continue to believe it long after they are in a tiny minority.

As the ink barely dries on the proposed Irish debt agreement with the IMF and the ECB we are hearing that Portugal and Spain are next up. We watch the finance ministers of both countries try to respond to questions equivalent to “when did you stop beating your wife?” Many of us could actually write the stories that will appear in the financial newspapers about the collapse of Portugal and Spain right now. They are predictable. What is not predictable is how people will respond.

It’s always been my experience that it is just when you think there can’t be any alternative to what you expect to happen – an alternative appears. So will the three countries subject themselves to draconian cuts in their budgets and standards of living one after another? Will we see a few street demonstrations, some smashed cars and then a close vote in the government to implement an austerity plan? Perhaps. But if my father’s side of the family is any indication, the Irish can be a difficult lot. They might surprise us and do something worth paying attention to – Really!

The French and the Fat Lady

2010-11-22T12:11:00.000-05:00

Every American school child learns of the exploits of the Marquis de Lafayette during the Revolutionary War. Some go on to read Alexis de Tocqueville’s Democracy in America and learn of the author’s admiration for the establishment of our democratic state. In these early days it seemed that there was a love affair between the two countries. But as we all know, those feelings changed and until quite recently there had been bad blood for some time.

If you look at the history of currencies backed by precious metals you find that countries who employed them usually printed more money than they had gold in their vaults during wartime. The imbalance was usually quickly corrected once the conflict was over. But the Vietnam War went on for a long time, much longer than any previous US war and the imbalance became exacerbated. In 1971 the French, alarmed by the discrepancy and concerned about the value of the dollars they were holding decided to demand the metal instead of hanging on to the increasingly worthless paper. The result was Nixon’s famous act of slamming shut the “gold window” and turning the dollar into a fiat currency. He blamed it on speculators but those in the know saw the French position as an act of betrayal. Coming on the heels of the French withdrawal from NATO several years earlier, the relationship became very frosty

More recently, French opposition to the Iraq War brought the disenchantment into the public arena. Some believed that France was trying to protect its trading relationship with Iraq; others thought it was a calculated move to diminish the clout of the world’s only remaining superpower. The animus became heated. People who seemed to have a lot of time on their hands began a campaign to rename the French fry although one doubts that the French were overly concerned about being disassociated with potato slices boiled in oil.

Despite the cordial relations that have developed between Sarkozy and Obama it is clear that the French have made a habit out of disagreeing with the United States and lots of people here don’t like it. They are doing it again although not at the governmental level and out of sight of most media outlets. If they are successful the impact will be dramatic.

Enter Frenchman Eric Cantona – dubbed “King Eric” and wearing the famous number 7 for Manchester United, he became an actor following his retirement from football. In recent days he has appeared in a YouTube video that is achieving viral status (you can find it here). In this short clip with English sub-titles Mr. Cantona makes some very clear and, in some quarters, very frightening statements.

First, he points out that public demonstrations are fundamentally a waste of time. Back in the days of the Nixon administration they had a dramatic effect. Now the only news item that is generated from them is a debate about the number of attendees. So he is certainly right on that account.

Second, he dismisses violence as an effective tool in changing the status quo. Again, he states what has become sadly obvious. The world has become inured to the savagery that occurs daily. Stalin, it seems was right – “One death is a tragedy; one million is a statistic”. Violence, for those who are not its immediate target, changes nothing.

But Mr. Cantona’s third point, while not a new idea, may be one whose impact could be profound. He encourages people to withdraw their money from banks on a specific date. An organized run on the banks he believes will have the effect of causing them to collapse. What occurs when that happens is left to the imagination.

Whether or not this effort will be successful it marks a distinct departure from the current conversations about the economic crisis. It is a tactic that comes from the traditions of Gandhi and King. It is an act of withdrawing (literally) from the system. It worked in the Salt March to Dandi and the Montgomery Bus Boycott. It is almost impossible to defend against.

But there are differences between what Mr. Cantona advocates and what Gandhi and King wanted to achieve. The latter two had a goal; a vision of what the world could look like absent a clearly identified oppression. Mr. Cantona and others who wish the collapse of the banking system don’t seem to have articulated much of a vision aside from not wanting what currently exists. While that would be a very big concern in normal times we may want to consider the thinking of David Brooks, the conservative columnist from the New York Times. In his weekly appearance on the PBS News Hour several weeks ago Mr. Brooks suggested that change can come from two different areas – leaders and societies. While most of the time we look to leaders he thought this was a time when societies would actually be the source of new ways of thinking.

Societies are somewhat amorphous masses. It’s hard to figure out what is going on until something happens and then we go back and look for influences. Mr. Cantona and company may be one of those influences – or not. What does seem to be emerging is a wide range of ideas about what new economic models might look like. What finally emerges will likely be the result of different groups trying different things; that’s not a very sanguine thought for those who prize stability.

It is hard to find anyone (aside from the jabbering heads on cable news) who is optimistic about our global monetary system. It’s true that it ain’t over until the fat lady sings, but she is warming up her vocal chords backstage in her dressing room. We can hear her.

Fear, Rage and Bad Decisions

2010-11-15T09:17:00.001-05:00

I spent the first ten years of my adult life working in psychiatric facilities – in those days called mental institutions or even “loony bins” by my insensitive friends. I got the job right out of college. I simply showed up at the administration building at Manhattan State Hospital and announced that I was reporting for work. There was a bit of a kerfuffle (that’s Scottish meaning “disorder”). I hadn’t really been hired at all. After about fifteen minutes of toing and froing I was given a job as a teacher in the children’s unit that consisted of pre-adolescent boys aged 5 - 12. In retrospect it seemed like the only way an Episcopalian lad from Connecticut could have gotten himself into a psychiatric hospital in those days. It also taught me something about the fragility of bureaucracies in the face of determination.

I had no training. I did have a BA in English and I had read Kesey’s One Flew Over the Cuckoo’s Nest so I thought I had a vague idea of what I was getting into. I didn’t. Instead of classic disorders identified in the DSM (Diagnostic and Statistical Manual of Mental Disorders) what I found was a colossal amount of rage – and not just on the part of the patients. They were angry because they couldn’t communicate in a manner that could be understood by the adults in their lives but there was also rage on the part of the staff who wrapped themselves in the idea that professionalism required detachment.

And there were, of course, worse things going on. If you tried to run away the Director of the unit took one of your shoes away for a week. If you were unlucky enough to merit therapy the resident psychiatrist/pedophile made you wear a dress. It was worse than Kesey’s imagination.

But those were the days of social protest and some of us got together and put up a fight. People were fired. A new children’s hospital was built. I got a job running the new adolescent unit (still with no formal training – which should have been a hint). Instead of beatings and unspeakable humiliations there was a shift to what at the time were very primitive psychotropic drugs. After a confrontation with a doctor who wanted to give a 12 year old a liver destroying injection of Thorazine I was taken aside and told that psychiatric facilities were agencies of social control and that if I didn’t like it I should get out. And so I did.

But my experiences in those days taught me that rage is born of fear and fear is a very dangerous emotion for human beings in complex societies. The fight or flight response to fear is tactical and immediate. The forces in our global society are subtle and interconnected. Human fear always results in what prosecutors call the SODDI defense (some other dude did it). Assigning blame is like comfort food and we’ve been eating a lot of it.

At this writing our monetary system appears to be teetering on the edge of collapse. We are being told that our lack of jobs here in the US has to do with the value of the Chinese currency. Governments throughout the Western world are telling their citizens that social programs must be cut to balance budgets sometime in the future. Ireland has joined Greece as a basket case.

We all seem to have forgotten Fannie and Freddie. They are still in business and still hemorrhaging money. Those credit agencies – Moody’s, Standard and Poor’s and Fitch? Yup, still in business and no sign of reforming the process of banks paying their fees. Too big to fail is bigger. The G20 meeting that just concluded had the singular achievement of communicating its inability to do something about anything.

The recent elections in the US indicate that people are angry. But they have precious few outlets for expressing that anger. Voting once every several years is hardly an effective release. Venting in the blogosphere, on talk radio and cable television has lost its cathartic value. Blaming someone else seems to be what’s left.

And that is very dangerous on many levels. The potential for war or rather, more wars, increases. Our ability to think clearly is diminished. Quick fixes, simple answers become more appealing. But if we go down that path we will simply be making a decision equivalent to exchanging the loss of a shoe for the loss of a liver.

It's the money, stupid.

2010-11-07T12:49:00.001-05:00

Some thirty plus years ago I read a book entitled Man’s Worldly Goods, The Story of the Wealth of Nations by Leo Huberman. Mr. Huberman was an avowed socialist and co-founder of The Monthly Review – a dyed in the wool lefty if there ever was one. My recollection is that his book was easy to read and an interesting history of how wealth was defined over time and through a number of different economic systems.

One idea from the book stuck with me; Mr. Huberman suggested that political reality is always at least one generation behind economic reality. People might consider themselves as citizens of a particular country but the economic system in which they operate crosses borders at will. Perhaps we might update that idea to say that economic reality is always at least one generation behind monetary reality. The manner in which money is created and wealth is calculated is becoming more and more detached from global economic activity.

The Federal Reserve and the Bank of Japan initiated another round of quantitative easing last week; these two central banks are buying debt instruments; in the US the target is Treasury bonds (for now), in Japan it is virtually any kind of debt. The expectation is that these efforts will make the currencies of these countries less valuable with a resulting increase in exports, their debt instruments will be less valuable because of lower yields and money will flow out of bonds and into stocks. The market will rise, people will feel richer and the economy will expand.

But the logic behind this practice is looking more and more like a pretzel. The central banks create money by creating debt. While it is true that the Federal Reserve is virtually giving money to the banks, the principle still holds when the banks use that money to create loans and thus, more money. Some of that created money was invested by the banks in another debt instrument called a Treasury bond which is now being purchased by the central bank that will create the money to buy it. It’s difficult to follow. One ends up wondering where the value is.

The vast majority of us believe that money is necessary to survive. We use it to buy things we need and, although less so these days, things we want. But the monetary system on which that belief rests has become extraordinarily abstract and complex. Paper money that we carry around in our pockets and wallets is just a tiny fraction of the total; all the rest are digital dollars.

Taleb, in his book The Black Swan tells us that complexity and volatility are inextricably linked. We have an economic system, capitalism, which requires volatility. You can either be successful or you can fail. Failure by some is not only an option in this system, it is a requirement. But we have gotten to a point where we can’t tolerate any failure because the system has become so complex no one really knows what will happen if we have another Lehman Brothers. The problem is that the attempts to force stability by manipulating interest rates or enforcing regulations just end up creating greater instability.

Add to all this the results of the elections in the US last week (and hence the play on words from James Carville’s admonition to the Clinton campaign staff in 1992 in the title of this piece). The message, once you get past all the posturing by the left and the right, was pretty clear. Too many people don’t have jobs and the ones who do are afraid that they might lose them. An expectation has been created that the political process can address that problem. No one has really explained exactly how.

Technology is eliminating jobs and the increase in population (a subject we’ve all decided not to talk about) is dramatically increasing the number of people who want jobs. The prospect of unemployment increasing is not politically palatable so both parties run around talking about stimulus or tax cuts all the while hoping against hope that something good happens.

We choose not to see how rapidly things are changing as we live our daily lives. Drop someone from the early 1980’s into today’s environment and they would have some difficulty understanding why it is that much of the population walks around with their eyes glued to little hand held devices. They would also be astonished at the price of a candy bar and a telephone call. They would be terrified at the level of debt, not just in this country but around the world. Things have changed a lot in a short period of time.

We would all like to believe that we are going through a normal, albeit very difficult business cycle. Things will get better – they always have. But we may want to consider that some of our assumptions just don’t hold water any more. The debt we have is too large to be addressed by budget cuts and our grandchildren aren’t going to pay it back. The jobs we want are disappearing because of the technology we invented to enhance productivity. The money that we work for has become a pile of abstractions so complex that it is virtually impossible to understand. It’s easy to list the problems. It’s easy to demonize someone else. But the real questions remain.

There is a quotation from Einstein that I’ve used before: “No problem can be solved from the same level of consciousness that created it.” There are some fundamentals in play here – the idea that everyone can get a job, the idea that working at a job will earn money that has value, the idea that debt is a reasonable vehicle to create that money. All these ideas are under tremendous stress. New ideas are emerging - like contributionism and time banks that still seem utopian in the current context but offer a new way of thinking about commerce and the concept of exchange. When you get past all the noise about “what should be” you can begin to work on “what could be”. Time is short.

QE2 - The Last Resort

2010-10-29T07:49:00.002-05:00

The Federal Reserve’s second round of Quantitative Easing or QE2 is set to launch next week. Ask yourself and a half a dozen of your friends if you really know what that means. Most of us don’t.

Quantitative Easing was invented by the Bank of Japan during the 1990’s. The idea is that the central bank creates money and buys bond assets from banks and other financial institutions. That puts more money in the hands of the banks which they can then use to create even more money. Theoretically, this money will then be lent to businesses that will use it to invest in their physical plants and hire people and get the economy moving. It is often described as a last resort. The reason it is called QE2 is because we have already tried it once before.

The danger is that too much money will be flooded into the economy and high inflation or even hyperinflation could occur. So far, that hasn’t happened. Banks are not lending – not really. They aren’t lending for two reasons. From a regulatory perspective they know that they will attract tremendous scrutiny if they make questionable or high risk loans. More importantly they understand what all of us understand – there is something fundamental going on in the economy that is hard to fully comprehend. But there are some hints.

The recent revelations that there were “robo-signers” in the processing of mortgages made headlines for a few days. The documents underlying the foreclosure processes of many of the big banks were fraudulent. That resulted in a pause in the foreclosure process but Bank of America has announced that it will resume foreclosures despite the mobilizing of state Attorneys General to oppose them. That’s because the exposure from the lawsuits filed by the states and the homeowners are a minor problem compared to the lawsuits that are looming from the institutional investors. Those investors - pension funds, mutual funds, etc. will expose organized fraud in the system. It is one thing to say you were sloppy about the paperwork when processing a foreclosure. It is quite another indeed to admit that you systematically lied about the products you were selling.

Both events, QE2 and the impending collapse in confidence in the mortgage backed securities market demonstrate to the world that our money is worth far less than we believe that it is worth. For the past forty years we have had a fiat currency. That’s a currency that is not backed by a precious metal such as gold. A dollar has been worth a dollar because we said so – and we had the economy and the military power to back it up. That covered a multitude of sins. It’s always dangerous when you believe your own press releases.

The countries that hold our debt, most notably China, have reason to be upset. Should their investments turn out to be worth considerably less than advertised (and they certainly are) the impact will be severe, not just within their borders, but around the world. The dollar, despite half- hearted attempts to create an alternative, is still the reserve currency.

For the first ten years of my adult life I had the opportunity to work in a series of psychiatric facilities. During that time I discovered that the boundary between what was considered sane and insane moved on a regular basis, sometimes quite dramatically. Certainly we look back on the burning of witches or the enslavement of other humans as bizarre behavior even though entire civilizations accepted them as normal. We only need look back ten years to find a delusional system called the “new economy” in which websites with no discernable product, service or even functionality were worth millions. We pass through these experiences and we are reluctant to call them “crazy”. It must be something else.

Our monetary system is a belief system. A dollar has value because we (that’s the big “we” as in virtually all of us on the globe) believe that it does. That belief is in a very precarious position. We keep getting more and more information that questions its veracity. The result of abandoning our belief in our currency is beyond comprehension. Perhaps that is why, so far, we haven’t.

But beliefs can change very quickly. We discover that the lover we trusted has betrayed us and everything comes into question. What we thought was real turns out to be false and we redefine our experience. Sometimes this takes a long time, sometimes it happens very quickly. It is hard to know if the dollar is in for a long decline or an abrupt fall. What is clear is that we have emptied the toolbox. We are out of strategies to fix it.

The Risk of "Making Money"

2010-10-24T10:38:00.000-05:00

The only organization that makes money is a bank. The Federal Reserve creates or “prints” money. As the effective interest rate at the Fed is essentially zero that money is basically being given to its shareholders, the chartered banks of the United States. Those banks can then create more money through the process of fractional reserve lending.

All the rest of us have to make a product or a service. We have gotten to the point where the only metric that we use to determine the success of our efforts is an accounting of how much money we take in by selling our product or service. That metric, by its very nature, tells us how we have done, not how we are doing or how we might do in the future. Nonetheless, we all seem to be transfixed by how much money we have made or lost in the past and we make decisions about the future based on very dated information. No matter how many times this approach blows up in our faces we perseverate. It is Einstein’s definition of insanity.

Those of us who are involved in this new profession called risk management are in a lot of trouble. If we look at the past we can see that we have generated a good deal of income. Sarbanes Oxely was a godsend. Dodd/Frank holds out the same promise. Foolishly, some of us feel that we can breathe easier. The time between regulatory implementations can be a tough slog.

Except it is becoming clearer to everyone that none of this activity actually manages risk. From a structural standpoint it is impossible for individual companies to do anything more than comply with laws and regulations. In obeying the law they achieve the lowest acceptable standards for participating in the marketplace. It is true that regulations are an attempt to manage systemic risk but the risk manager in the two examples mentioned above is, heaven help us, Congress. The fact that regulations cannot and have not ever managed systemic risk is a subject for a different day. Suffice it to say that those of us who are involved in helping companies comply with the law are earning an honest living but we aren’t remotely managing risk.

So, if risk management is not about obeying the law, what exactly is it. Recently a few alternate explanations have emerged. One is that risk managers are the conscience of the organization. They act as the voice of reason to CEO’s who want to embark on some sort of misadventure and Boards of Directors who are all too ready to let them. It’s a bit delusional. If senior executives are intent on destructive behavior is it really conceivable that they will suddenly see the light because of what someone in the risk management department has to say? Witness the elaborate risk management diagrams and organizational charts produced for BP’s Board even as the companies operating environment was blowing people up years before the Gulf spill and you will have your answer.

We are in perilous times. Our global monetary system is collapsing. Our consumer economy is shrinking. Companies are reporting increased profits along with decreased revenues. If the definition of risk is about making sure that bad things don’t happen, it is truly a fool’s errand these days.

At the same time human knowledge is expanding with an ever increasing velocity. The potential to produce products and services that address fundamental issues has never been greater. Great companies, regardless of their size understand that “making money” is a byproduct of excellence. For those companies the management of risk requires the answering of two questions:

What do we want to achieve?

How do we want to achieve it?

And the asking of one:

What do we need to do to be successful?

The response to this last question is the list of risks that need to be embraced and managed. Taking a chance is the only thing that allows for success. What chance to take can only be determined by understanding what it is that you actually want to achieve.

The Means of Exchange

2010-10-15T09:06:00.000-05:00

The past several weeks have seen new revelations about the complexity of the mortgage industry and the astonishing level of sloppy work done to document that complexity. We are on the verge of massive lawsuits and a good deal of wailing and gnashing of teeth on the part of the banks that issued the loans and the entities that processed, repackaged and sold them as securities. According to William D. Cohan’s piece in the New York Times the banks not only knew about the problem, they hired a company to tell them all about it and then apparently ignored their report.

This is but the latest revelation in the unwinding of our monetary system. It is a symptom of a fundamental underlying problem. Much of the debate has been and is seems will continue to be whether or not we should ignore moral hazard or root out and punish the greedy. Viewed in terms of the current argument, there doesn’t seem to be a solution. People are living in houses that they couldn’t afford and now are worth less than the debt that encumbers them. Banks extended loans with the knowledge they were unlikely to be paid and then failed to comply with the legal requirements which simply mirror the complexity of the securities that were created. A fine mess.

Last night a nameless spokesperson for the Bank of America insisted that even if the bank hadn’t obeyed the law, the underlying facts were accurate. In other words, people had taken out mortgages, weren’t paying and should lose their homes. As the AG’s of forty states join together to halt foreclosures and the debate rages about what should be done we will not doubt hear more of the same. But the laws were written so that the banks could resell, package and securitize the mortgages. Which set of rules should apply? Eventually we will reach a compromise on this issue. People can’t own homes for free and banks can’t decide which part of the law they want to obey. But even as we develop a solution that no one will like we will not have addressed the core issue.

For the last thousand years we have had a debt based monetary system in one form or another. Where money comes from remains a mystery to most people. We teach very little about how our economy works and how we get money into that economic system in our public and private schools – even at the high school level. When people do educate themselves it seems that many of them feel compelled to write about what they have learned in capital letters on the Internet. It’s difficult to have a dispassionate discussion about money when more and more people don’t have any, but we really don’t have much choice in the matter.

It is not new that we have very large issues that we choose not to address. As anyone who has lived through a failed marriage knows, ignoring problems doesn’t make them go away – they simply get bigger. That’s what is happening now. The drive to address the demands of interest on the debt exploits a human trait that we call greed – not the other way around. Those who insist that our solutions lie in the thoughts of the 18th century minds who created the US Constitution, brilliant though they may have been, are missing the point.

Money is a means of exchange. It is developed as cultures become more complex. Accumulating money gives individuals and organizations power, but only up to a point. In the past, disproportionate accumulation has met with societal resistance sometimes manifesting in revolution. An increasingly vocal minority seem to be insisting that we are at this point again. But returning to simpler times is not really a viable solution. We are hopelessly interconnected (or perhaps hopefully) with each other across national borders. We have to begin to discuss and address the issue of money, interest and debt. It could be argued that the current debt-based system has served us well and perhaps, on balance, it has. But nothing is forever and it would be useful if we began to think about whether the level of complexity in our means of exchange can reasonably be expected to serve us in the future.

Vote Like an Iraqi

2010-05-25T13:23:00.000-05:00

This past March there was an election in Iraq. 62% of the eligible voters turned out despite the very real danger of being blown to smithereens. This November we will have mid-term Congressional elections in the United States. If recent history is any measure it is very likely that 62% of the eligible voters will not vote. The last time more than 40% of us voted in mid-term elections was in 1970. You can take a look at these statistics here: http://www.infoplease.com/ipa/A0781453.html

We are already hearing about the growing turmoil in the electorate. In Utah a conservative Republican senator lost his party’s nomination. The Tea Party prevailed in Tennessee. The political class is all atwitter (alas, literally). But we should not be misled into thinking that these political upheavals are the harbinger of greater voter participations; in fact the predictions for these races is that turnout will be low with only the most dedicated party stalwarts making it to the polls.

In 1886 the Supreme Court agreed to review Santa Clara County v. Southern Pacific Railroad Company. It was a case that had to do with whether or not a corporation could deduct the amount of their mortgages from the taxable value of their property, a right grated to individuals at the time. In a statement prior to oral argument, Justice Morrison Remick Waite made the following pronouncement:

The court does not wish to hear argument on the question whether the provision in the Fourteenth Amendment to the Constitution, which forbids a State to deny to any person within its jurisdiction the equal protection of the laws, applies to these corporations. We are all of opinion that it does.

And so, without the benefit of argument or formal debate by the Justices of the Supreme Court, corporations became equivalent to people. In the esoteric world of legal scholarship there has been an occasional debate about the constitutionality of this pronouncement. Corporations are, after all owned by shareholders, some of whom are people and therefore wouldn’t the ownership of an entity considered a person by other persons violate the Thirteenth Amendment which expressly prohibits slavery? But I’m afraid this argument never really saw the light of day. A corporation has been a person in the United States for the past 128 years.

While it is true that corporations don’t vote as individuals we have all become very aware of their immense influence on our political system. Through the lobbying process they vote every day and outgun any grassroots advocacy groups with massive campaign contributions. Periodically, we see a news story about how the day jobs of most of the people in Congress is raising money to get re-elected but these reports don’t seem to galvanize much of a response.

The political process, much like nature, abhors a vacuum. When people don’t vote they abdicate their power to others. Pundits can decry the influence of corporations in government but corporations actually act responsibly in the context of generating maximum return for their shareholders. There is no conspiracy here. There is just a population willing to sacrifice the blood of some of their citizens and the treasure of their country for democratic principles in which they apparently have no interest. The results are predictable.

For the past generation political campaigns have had the quality of daytime television. Along with the sex we have posturing and platforms that rival the most ludicrous plotlines of soap operas. We don’t discuss complex problems and their solutions because we have convinced ourselves that we don’t have the intellect or patience to understand how to really solve a problem. And so, the elections in November will likely resemble the elections of the past. A few new faces a la the Republican revolution of the 90’s but very little difference in terms of substantive change in the political process.

It would seem to me that the way to change the current political equation is fairly simple and mundane – vote like an Iraqi. A voter turnout of 62% in this country would result in a seismic shift in political power.

But who should we vote for? Frankly, it doesn’t seem to make much difference. We just passed a healthcare bill with striking similarities to the one that Massachusetts has – one that was passed in that state under the leadership of the Republican Mitt Romney who is counting on public amnesia as he continues his campaign for the nomination he couldn’t get in 2008. Under Bush we started two wars. Under Obama we’ve expanded that to 2 ½ if you count Pakistan and the other “secret” actions under way in the Middle East. Financial reform has been gutted and we seem no closer to immigration reform than we were under Bush.

That’s not to say that a point of view or position on these issues and others doesn’t matter, it just doesn’t matter in the current political process where the citizens have abdicated their responsibility to get off their duffs every two years and vote. So, at the end of the day it is really fairly simple. Vote, even as you hold your nose, or don’t vote for whatever reason you’ve managed to cook up for yourself.

But a cautionary note. If we ever did get a participation level like that in the country that we bestowed democracy on it would be just the beginning. Then we would have to figure out what it is that we do want rather than our current preoccupation with everything that we don’t want.

The Problem With Green

2010-05-04T08:16:00.001-05:00

In the first decade of the twentieth century, Nikola Tesla built the first “Tesla Tower” at Shoreham, Long Island with funding from JP Morgan. His intent was to transmit electrical energy without wires from the huge reserve in Niagara Falls and, ultimately through the atmosphere and the ground to the whole planet. Sounds like science fiction, but Tesla never got to put his theory to the test. JP Morgan, the story goes, wanted to know how one would be able to attach a meter to the system to generate profit and when there was no clear answer he ceased to fund the project.

Over the past several decades we have labeled efforts to provide energy from sources other than fossil fuels as “green”. Green, being the color of the leaves of most trees and grasses, has an appealing association to the natural world. Green is good. Not-green is bad. Green has the cache of respecting nature and preserving species. Not-green is destructive in all its forms.

We’ve accelerated this divisiveness with the argument about whether or not the planet is warming as a result of the burning of these not-green fossil fuels. Over the past year the global warming deniers have gleefully pointed to corrupted data and correspondence that seems to confirm manipulation and deception. In the meantime, governments do little except to establish emission standards that barely slow the increase in the amount of carbon pumped into the atmosphere. It would seem that we cannot address any issue, from immigration to healthcare to taxation without first establishing polarity. Unless there is someone we can blame for a problem we cannot begin to mobilize ourselves toward a solution. Unless there is someone to defeat we cannot claim success.

As I write this there is a wellhead in the Gulf of Mexico that is pumping oil at a furious rate (some estimates are 200,000 gallons a day) into the water. The platform that exploded and sank on top of this wellhead was engaged in accessing oil three miles below the surface – a mile down through the water and then at least another two miles below the surface of the seabed. There are another 55 of these platforms in the Gulf.

Over the next weeks we will see increasing numbers of photographs of dead wildlife and anguished humans whose way of life has been disrupted if not destroyed. Unlike the Exxon Valdez which had a finite capacity to cause damage, this wellhead will continue to pump oil into the water. Given that its design lies at the very limits of what can only be described as an incredible engineering effort, the ability to stop the flow any time soon is highly doubtful. We will also suffer through a good deal of righteous indignation, finger pointing and denials. One side will point to the unbelievable damage, the other will argue that energy independence requires increased risk taking.

While it would rob both sides of this righteous indignation it might be useful to redefine the issue in the context of the views of Tesla and Morgan. Sources of energy can either be free or not-free. The sources that are not free require that we extract them from the earth (oil, gas, coal, uranium). We know that the process of converting them into energy results in generating substances that, in confined spaces will kill us. We also know that the efficiency of converting these substances far exceeds the ability to convert free energy sources (solar, wind, geothermal, tidal, etc.).

But our technological prowess has hidden the increasingly inefficient process of obtaining the not-free energy sources. We are not drilling three plus miles below the surface of our oceans for the fun of it. We are doing it because we have to – that’s where the available oil is. The recent coal mining disaster in West Virginia demonstrated a similar depth and use of technology to extract that energy source. The amount of energy that it takes to get at these sources is increasing; the delta between the energy source obtained and what it takes to get it is shrinking.

Ultimately, (and sooner than we probably expect) we will become aware that continuing to pursue the not-free sources of energy is a bad business model. They make less and less economic sense despite the global infrastructure in place to find, dig or drill them out of the ground, transport, refine, transport them again multiple times and then heat or burn them. That said, the enormity of the effort in moving towards using free sources of energy is almost incomprehensible. How could it possibly be accomplished in an economic climate that is still teetering on collapse? There aren’t enough engineers, solar panels or wind turbines to even make a dent in the daily energy requirements of the world today, not to mention the increased requirement that we face as population levels accelerate. In the context of what we know today and the resources that we have, the problems seems insoluble.

In 1983, when I straightened up and got a regular job in the financial industry I was given an office and a computer. It was an IBM XT. It had 128KB of memory and a blinking C:> on the screen. Very soon, Moore’s law was established and now we all carry cell phones with excess capacity that the vast majority of us will never use. It’s hard for us to remember what life was like ten or fifteen years ago.

Human knowledge, ingenuity and the resulting technology are expanding at a rate that seems impossible to grasp. We take it for granted because we can’t really comprehend the rapidity of its growth. Does that mean that there is a miracle right around the corner that will save us from what looks like serious disruption as not-free sources of energy become less and less economically viable? Doubtful. But it does provide us with recent experience that demonstrates our ability to outstrip even the most expansive of our expectations.

The Internet is full of explanations about why we will fail in the transition to free energy sources. There are intricate calculations that prove that we will soon be living in caves and barely subsisting on a reduced diet. To the degree that this kind of analysis makes people aware that there is a problem it is useful. To the degree that it makes people despair it is destructive. Anyone who devotes the requisite amount of time can demonstrate why something can’t happen. At some point these explanations are analogous to Chinese food – tastes great but is somehow not particularly fulfilling.

The problem with projecting solutions these days is that it is increasingly difficult to rely on the past as a predictor (hence the example of how computing capacity has outstripped our projections and, perhaps more importantly, our needs). We have a big problem. Our not-free energy sources are becoming increasingly inefficient – not at the point of conversion from the source to the energy but in the production cycle from finding it to delivering it. Technology is masking the problem, catastrophes cloud the issue.

Free sources of energy pose not only a technological problem but and economic and political one as well. What does an economic system look like when the source of energy is free? Certainly there is money to be made is building and installing the devices to capture the energy but what happens when a household can generate more than it can use? What happens if we move from an economic model based on scarcity to one based on abundance? We don’t know but, despite the increasing rate and size of the calamities in the world, I think we are going to find out.

Greece: The Demand for Sustainable Tragedy

2010-02-25T12:22:00.003-05:00

There is an article in the New York Times this morning (http://www.nytimes.com/2010/02/25/business/global/25swaps.html?hp ) about the role that credit default swaps (CDS’s) are playing in the financial crisis in Greece. CDS’s are essentially insurance policies for bonds. Investors buy them when they believe that there is an increased likelihood of the interest and principal of the bonds in which they invest not being paid back. The cost of insuring Greek bonds has, understandably, risen dramatically. The Times article points out that the increased cost of providing insurance has the effect of forcing the bond issuer (in this case the Greek government who has been delaying a new bond issue) to raise the interest on the debt that they try to sell in the marketplace. Investors are not going to buy bonds when the cost of insuring them wipes out any profit that they can make. So the formula is: Interest – CDS cost = profit; and the CDS cost continues to rise.

Since they are selling the bonds to pay down the interest on previous bonds, the fact that they are incurring even more interest obligations in the future essentially means that they will never get out of debt – regardless of whatever austerity measures they are able to impose on a populace that is increasingly restive.

But here’s the real problem. For those who issue CDS’s and those who buy them it is essential that Greece not default in its debt. It can only appear to be extremely likely to default. The more likely the default, the more valuable the insurance policies and the greater the price that can be demanded for them (let’s remember that you don’t have to own any Greek bonds to buy insurance on them). If, however, a default occurs those who own the CDS’s will more than likely find themselves trying to collect from an AIG-type corporation or bank who issued the swaps – and there is no way that that corporation or bank has the financial wherewithal to pay off on the insurance policies.

In order for everyone to make money Greece must twist in the wind right up to the point of collapse before the European Union and/or the IMF provides the funding for a bailout. The fact that this will just be a temporary fix at best is of no concern in the marketplace. The dynamic of near collapse and failure are at the core of the engine that drives the creation of value in this situation. We can look at what is happening in Greece and be appalled at the avarice of those who are engaged in profiting from failure but we would be better served to be dispassionate in our understanding of the market dynamics while at the same time being empathic with the human beings whose lives are impacted.

We are witnessing the law of cause and effect. Some here in the United States would have us believe that the cause is profligate spending by grossly inefficient governments and there is surely a good deal of evidence to support their views. But rolling back the function of government to a time before the advent of interstate highways, social security, women’s suffrage, the 40 hour work week and indoor plumbing hardly seems like a feasible approach. We are where we are. We have a global economy and a debt based monetary system and it would seem that the debt levels have finally reached a point where the most optimistic (and one might say, delusional) projections of growth will hardly make a dent.

Something has to give and one only has to look at the reports coming in from state and local governments that are on the brink of collapse to see that we are all in for a serious downward shift in what we can expect in terms of services that we have taken for granted for so long. Everything from education and public safety to garbage pick-ups will suffer in the current economic paradigm. The rhetoric will become more shrill and the public reactions more strident. The predictions of social upheaval both here in the US and around the world seem more credible than they did at the height of the collapse over a year ago.

But if we go back to a dispassionate analysis, a cause and effect analysis of the situation in Greece we can see that it is not only likely but inevitable that the market dynamics there will be repeated in Spain, Portugal, Italy and Ireland (the rest of the so-called PIIGS countries) before it moves on to what would appear to be more stable economies. We can cast aspersions on those who participate in this economic carnage but we would be wise to understand that it is a system in which we have all participated in some fashion and, in a material sense, benefitted from. As it falls apart we would do well to focus on building something more sustainable rather than casting ourselves as victims of those whose actions we convince ourselves we had nothing to do with. Certainly Bernie Madoff raised the concept of a psychopathic personality to new levels but he did so with the encouragement of those he victimized who couldn’t see past the unrealistic profits they hoped to realize.

We now live in a world that depends on the perception of catastrophic failure while at the same time demanding that it won’t actually happen. It’s a perpetual soap opera where the heroine lurches from one unbelievable scenario to the next and always escapes unscathed. As Lehman and AIG demonstrated, it’s a very dangerous game.

Change

2010-02-06T16:11:00.002-05:00

Change. People say they want it. Nobody really likes it. Everyone is sure they are not getting it. Yet it seems obvious that there is a great deal of change going on. From the negative perspective your house, if you own one, is worth a lot less than it was a year and a half ago. Close to 4 out of 10 of us in the United States are obese and the number is steadily rising. 2 out of 10 adults who want a full time job in this country don’t have one.

But that’s not the change we wanted. We wanted good change. Okay, there’s a lot of that as well. Paul Stamets has discovered ways in which mushrooms can be used to clean up pollution, kill unwanted insects and cure disease. Bruce Lipton tells us that the placebo effect, where patients get well as the result of intention rather than pharmaceuticals is at least as effective as medical intervention. Nassim Haramein offers us a peer reviewed theory of singularity that changes our current conceptions of the universe.

Okay, that’s all interesting stuff but it wasn’t really what we had in mind. We want something more immediate, something that impacts our lives right now in a positive way. Even though Stamets, Lipton, Haramein and others are pointing us towards ideas and inventions that will affect us in fundamental ways, they seem of little consequence in the immediate moment.

We should note that some of the desire for change has been channeled into what we might call a growing “no change” movement. These are folks who want to go back to a point in time where their lives were not interfered with by the government. It’s unclear when that actually was but one of the core beliefs of this group is that any move towards collectively addressing social problems is a terrible mistake. Still, even in this group we can find a desire for something other than what we are experiencing now.

It was only a little more than a year ago when a large majority of the country had a very positive view of what change could mean. We had elected a President who held out a vision of a new way of politics, one in which a broad range of views could be accepted and crafted into policies based on consensus rather than contention. The reality of the political process dominated by the influence of money has dispelled that vision, but the desire for something fundamentally different in our experience has not gone away. It is almost as if the event of Obama’s election will always be more powerful and important than anything that his administration could accomplish.

We are left with that central question that many of us have such difficulty in answering – what is it that we want? Over the last several decades we have explored answering this question by itemizing the amount of money that we want to accumulate and the quantity of things it could buy. That’s not to say that some of us aren’t perseverating on that path, but the continuing economic crisis has caused many of us to re-evaluate that approach.

Gerald Celente of the Trends Research Institute has built a reputation as someone who has a good track record of identifying future events. We can find him on a variety of media outlets predicting political instability, tax revolts and food riots. What is often omitted is his prediction that we are entering a time of civility in our discourse and quality in our products and services. This will occur not because it is a good idea or because it is something that we should do. It will occur because a significant number of people decide that it is what they want – it is the change that they want.

It is notable in this context that last week the automobile company with perhaps the best reputation for quality, Toyota, announced the second largest recall in history for an accelerator pedal problem and then followed it up a few days later by revealing that they had a braking problem with the very popular hybrid Prius model. It turns out that they had known about the braking problem and corrected it in the newer models but left the older ones on the street without alerting their customers. One can only imagine the meetings in which that decision was made.

We don’t have to look very far to find other examples of companies and governmental institutions that put their own short term benefit above those who buy their products or elect them to represent their interests. The cynic would say that this is just more of the same. People will put up with it because they have to – there is no alternative. Certainly that has been the case in the past. It is the wise organization that questions whether it will be the case in the near future.

We live in a very different world than we did just ten years ago. We all know that the Internet has spawned countless groups of people who are communicating and collaborating in ways that were impossible a short time ago. We are also living in a time when those economies that we used to classify as emerging have now actually emerged and they are developing products and services that originate out of their own intellectual resources rather than depending on the old established economies for ideas and outsourced jobs. For many of us it is as though we are still driving on streets that used to be one way but the signs have been taken down and the traffic is moving in both directions.

Change was happening before we asked for it. The longer we delude ourselves that profit is the goal of economic activity rather than an index of the quality of a product or service the more we will frustrate ourselves in achieving the change we say we want. Quality is no longer a “nice-to-have” or a slogan to provide misdirection from the underlying strategy of planned obsolescence. Economics is really just another discipline that defines the way that we relate to each other. It changes when we change – not the other way around.

Predictions

2010-01-06T09:31:00.002-05:00

Over the past several weeks we have been deluged with the usual year-end predictions about what will occur in 2010. Some suggest that it will be the beginning of a transition to a fourth dimensional existence; others insist that the economic meltdown that will occur will make the collapse at the end of 2008 seem like child’s play. Some are based on trend analysis, others on psychic information. They all seem to have one message in common; get ready, something big is coming.

Several decades ago Daniel Kahneman and Amos Tversky did a series of experiments that demonstrated, among other things, that we all suffer from cognitive dysfunction; we never have enough information to make a well reasoned decision. Perhaps we should modify that conclusion as a result of the explosive evolution of the Internet; we cannot absorb enough information to make a well reasoned decision. The data is there if only we could make sense of it.

The unexpected event or Black Swan as Taleb calls it is supposed to be an occurrence that no one anticipates. Yet, if we look at the major and usually catastrophic events that we have experienced over the past decade we will always find someone, and in most cases, a goodly number of people who saw it coming. In retrospect their perceptions seem self-evident; at the time they were either ignored or met with derision. Our acceptance of what is predicted about the future seems always to be colored by what we wish would happen in the future based on what we are experiencing now. We limit ourselves.

The fact is that we know a great deal that we constantly ignore every day. Let’s assume that you are sitting at a heavy oak table. You know from middle school physics that the table is mostly empty space; the mass of the atoms in the table is minute while the “empty space” consists of electromagnetic fields. Your head, its bones, skin, and the brain itself have the same characteristics. However, if you bang your head on the table the solid density that you, I and everyone else perceives will become more “real” than the facts that we know. So we continue to act as though things are solid when we know that they are not and we learn to live with the paradox of our perceptions being out of kilter with what we know to be true. Invention is the attempt to reconcile these two experiences. The impossible becomes possible and prior experience seems quaint.

The Bureau of Labor Statistics tells us that productivity in the non-farm category went up 8.1% in the 3rd quarter of last year. In the manufacturing sector it went up 13.4% in the same time period. I can’t remember a quarter where the productivity of the US labor force went down. Regardless of the shape of the economy we seem to be able to crank out the work at an ever accelerating pace. Technology is a major factor. That and the fact that people are doing the same work for less money contribute to these amazing statistics. And yet at the same time our educational system is producing more and more people who lack the skills to secure and maintain anything but the most marginal employment. Does all this mean that there will be fewer jobs as a result of the mushrooming efficiency of technology or greater unemployment because the available workforce lacks skills? It probably means both. Will we perceive this lack of work as a tragedy or as an example of the advancement of our species? It’s hard to tell but it certainly means that our old models of employment and productivity are going to be exposed as inept measurements in the fairly near future.

The first commercial oil well was drilled in the middle of the 19th century; the last one will be drilled well before the middle of the 21st. Will this be the result of carbon taxes and global warming initiatives? I would suggest that those efforts will have marginal impact. What we know is that it takes us about five times the amount of energy to get oil out of the ground than it did a few decades ago. We know that demand is increasing and supply can only diminish. We also know that energy that we extract from the earth requires a tremendously complicated infrastructure to distribute and use it (find it, dig or drill it out, transport it, refine it, transport it, burn it).

There are those who insist that we will experience the modern equivalent of the Dark Ages when the oil runs out. It would be foolish to think that the transition from a fossil fuel economy won’t be disruptive but to insist on catastrophe suggests limited imagination.

So, given the acceleration of change that seems to be upon us, what should those of us in the risk management profession be doing these days? I would suggest the following:

1. Never attend a meeting unless you are absolutely sure that you are the dumbest guy in the room. Once there, ask questions the answers to which seem self-evident.

2. Assume that what you know is a very small percentage of what there is to know.

3. Take the results of models and methodologies with a shaker of salt.

4. Be leery of those who say our problems are the result of the exponential function but our solutions can only be linear

5. Above all, pay attention.

The Illusion of Safety

2009-12-21T08:34:00.002-05:00

http://sorms.blogspot.com/2009/12/illusion-of-safety.html

There is an assumption that one of the fundamental purposes of government is to provide for the safety of its citizens. One could argue that Americans enjoy that safety. There have been no terrorist attacks in the US since 9/11 and the crime rates in most cities have been declining for years. Although the world seems to be as uncertain a place as we have ever known in this generation we all operate as though we can get through our lives relatively unscathed. Yet we have more people in prison than any other country in the world and we manage to shoot and kill each other at rates that dwarf those in any other developed nation. Safety, it would seem, depends on your perspective.

That desire for safety has expanded into many other areas beyond just the physical. As the consumer society took off after World War II many of us became focused on securing our possessions as much as our persons. Avoiding loss became a cultural preoccupation and was manifested in products that promised a range of security from ensuring our attractiveness to the opposite sex to tracking our kid’s whereabouts via cell phones. We built mighty fortresses in our minds as though we could protect ourselves from any eventuality.

Over the last several decades we shifted the focus of our desire for safety from our persons and possessions to our money. Mutual funds became the primary destination of 401k’s and we convinced ourselves that there were people who were smarter than we were who knew how to grow our money. We continue to do this regardless of financial catastrophes and in the face of numerous reports that tell us that the DJIA continues to outperform these funds nearly 2 to 1. The perception of safety has become more important than the reality. We pay others to make less money on investments than we could make on our own and we do it because we are convinced that it is safer to let someone else make the decisions

Derivatives have their origin in that kind of thinking. Originally, before they became a source of wealth creation, they were designed to provide a hedge against a future transaction. That was a reasonable and prudent goal. In their current incarnation they have become the source of misery – their promise of safety shattered by the improbable assumptions on which they are based.

Within the risk management community there is an increasing debate on the utility of mathematical modeling. On one side there is the argument that the crisis has served to strengthen the models and they are now more robust than ever. The other side insists that recent events demonstrate the futility of predicting much of anything. It’s a bit of a specious argument. It’s reasonable to assume that there is more than a shred of truth in both positions. The real problem lies in our motivation; do we want to ensure safety or pursue opportunity. Pursuing opportunity certainly sounds like a loftier goal but it is messier process and it is foolish to think that outcomes can be guaranteed.

In the end, we are stuck with our own subjective judgment. Despite the protests of my quant friends that they can drive bias out of any model I would submit that as long as human beings are involved that goal will always be elusive. And so it should be. The purpose of life is not the avoidance of death – the purpose of life is life! It is the same for a company.

The current economic crisis has caused most corporations to adopt a defensive posture. They are cutting jobs and expenses. Some of them will survive but we should not be surprised if others, some of them well known brands, do not. The experience of the automotive industry tells us that poor design and substandard quality is difficult to turn around. Those companies and those people, however, who understand that the only reasonable goal is the pursuit of opportunity will not only survive, they will thrive. They see risk as the necessary ingredient that propels their ideas from concept to reality. They understand that strength comes from organizing people towards a goal and that uncertainty perceived as opportunity is much more powerful than pondering the list of possible calamities.

Derivatives and Faith

2009-11-18T13:56:00.001-05:00

In 1987 I joined a relatively small cadre of mid-career hires at JP Morgan. I and my new colleagues were needed because we had experience in putting up large high tech buildings and Morgan had just begun their headquarters project at 60 Wall Street. In those days the employees of the bank numbered between 12-14,000 and virtually all of them had come up through the internal training program. Understanding how the firm worked for a new arrival in those days was difficult. There seemed to be interminable rites of passage until you were deemed trustworthy. Once that happened, things became more fluid.

In the early 90’s there was a massive culture shock. Meetings were held and everyone was informed that they no longer had “a job for life”. We would remain employed only if there was a fit between the needs of the organization and the skills we had to offer. Lunch was no longer free – literally, although it still remained cheaper than going outside to the local deli. We all understood, many for the first time, that we were employed at will.

What happened over the next nearly two decades is a well known story. Jobs that didn’t provide strategic advantage were outsourced. Jobs were shed at the slightest sign of economic troubles and firms convinced themselves that they had become more nimble. Certainly, here in the United States it was infinitely easier to get rid of employees than in France. Even the UK provided some protection for workers. We looked down our noses at the Europeans.

But something else happened at the same time. People began to see their present jobs as an opportunity to enhance their resumes. While it was easier for companies to get rid of the less productive people it became increasingly difficult to hang on to the folks at the other end of the spectrum. The alignment of personal goals with corporate goals became the result of happenstance rather than mutual agreement. Internal theft soared. In an appeal involving a case in Illinois, the US Chamber of Commerce stated that $60 – 120 billion is lost each year to internal theft and it is the primary cause of 1/3 of all business failures. On a retail level, 70% of the theft is internal – which begs the question of the utility of all those plastic tags and security guards.

This was the unintended consequences of a sea change in the relationship between employees and employers and it didn’t take very much time at all. I am reminded that when I went to work at Manhattan State Hospital in 1969 there were several people who walked the grounds with tin foil hats on their heads. They insisted that they had had experiences with extraterrestrials and depending on their malady the hats were to either enhance or prevent further communication. Now we have global conventions devoted to sharing ET information and recently the Vatican lent credulity to these efforts.

The value embodied by derivatives is a matter of faith. You have to believe that you will be paid a certain amount when the value of the underlying asset changes in one direction or the other. The value of that underlying asset is determined by another act of faith – you have to believe that the value represented by a fiat currency has value. It’s a lot to ask, especially when there doesn’t seem to be any concrete utility attached to these financial instruments. Only a very small fraction is actually hedging a position where the parties are engaged in a transaction involving a real “thing”. All the rest is speculation.

Sometimes belief systems fade, sometimes they collapse. Certainly the credibility of ET sightings has taken a while to change and not everyone who insists that they have seen one is necessarily sane. There are also many people who have lost their jobs during the current economic crisis regardless of their skill level. But these two examples demonstrate to us that unintended consequences of grand schemes and even the boundaries of sanity can move much faster than we would anticipate.

The first mortgage backed security was issued by Ginne Mae in 1970. This level of abstraction in our financial system is only 40 years old. Since then we have created a world-wide belief system that has a fairly unique attribute – no one really understands it. What is apparent is that the expressed value of these financial instruments is larger than anyone can imagine and represents far more money than could ever be spent or invested. Non-financial people are beginning to wonder out loud what its utility is. Those who attempt to get their arms around what is going on suggest that the next crisis will involve commercial real estate and unfold over the next several years but we would all be wise to keep an open mind. What we believe and how the movement of the boundaries of what is considered sane is a very difficult thing to predict.

Money

2009-11-07T17:49:00.002-05:00

We live in a world where the means of exchange (money) has become vastly more important than what we exchange (goods and services). We have moved from a time when money or profit was one of several metrics by which a company could be judged to the only metric and more recently in many cases, to becoming the product of a company – buy our stock because we make money. How did we get here?

The history of money apparently has its origins in China around 1200 BCE where cowry shells were used as a means of exchange. If we fast forward to the Middle Ages in Europe we can find the origins of the modern banking system when people took their gold and silver coins and deposited them with the local goldsmith. The goldsmith found that only 10% of his deposits were ever withdrawn at any one time and he began what become known as fractional reserve lending (keep a fraction in reserve and lend the rest).

There are some fundamentals of that old system that are still in play today. We have a debt based monetary system. Banking and the creation of money is a private business. Someday NY Times columnists like Tom Friedman will understand that the loans from the Federal Reserve to IAG were not taxpayer bailouts. There is no way for dollars paid in taxes to get into the Federal Reserve unless they are used to pay interest on the money created by the Fed and loaned to the US government. Taxpayer dollars are not at risk in the AIG transaction; all the dollars are at risk. But I digress.

For centuries human beings have debased themselves in one way or another to accumulate money. Money was and is power. With it you could not only provide yourself with the basics, but have some toys as well – like big armies or iPods. Over the past fifty years we have elevated the accumulation of toys to an art form in the United States. So much so that over 60% of our economy is based on people buying things. Most of us believe that acquisition is the purpose of money.

A recent Wiki article (http://en.wikipedia.org/wiki/Stock_market ) states that as of October of 2008 the total value of all stocks in the world was $36.6 trillion and the total face value of all derivatives in the world was $791 trillion. Given that these numbers reflect the values shortly after the financial crash I’m sure that they have moved around a bit since then. But the ratio is likely the same – roughly 22:1. Derivatives are contracts to pay based on the performance of something else. It’s pretty clear that more than one contract has been written for each underlying asset. When things go south it’s no wonder that these contracts can’t be paid and it’s no wonder that there have major efforts to save the financial system; a system that is so abstract that no one really understands it.

Another number that is useful to think about is global GDP which is roughly $65 trillion – that’s the value of all the goods and services produced in the world.

So it is fairly easy to see that wealth or money has been decoupled from its ability to buy goods and services. There simply isn’t enough available to buy given all the wealth in the system. Economists will tell you that derivatives only have nominal value; that the vast number of derivatives cancel each other out because they are “bets” on whether something will happen – or not.

But let’s leave that discussion to the economists (they seem to be the only ones who want to talk about financial systems as though they are separate from the human experience and have a life of their own) and get back to thinking about money. If money is not a means of exchange, if it is not something that we can use to make our lives better or someone else’s life better – what is it? The more I look at the numbers the more I have come to conclude that I don’t know what it is any more. The only thing that seems clear is that we are tenuously hanging on to the idea that somehow all allegedly sophisticated financial instruments have value – an idea that is under constant daily attack.

The story of what is said to be the world’s first large economic bubble may provide some clues as to where we go from here. In 1593 tulip bulbs were brought from Turkey to the Netherlands. Initially these flowers were prized for their relative rarity but then a non-fatal virus caused the bulbs to produce very unusual flowers – they appeared to have “flames” of different colors and their value increased exponentially. Many citizens mortgaged their homes and businesses to invest. The resulting crash seems obvious in retrospect. One can imagine how the collective unconscious tapped the Dutch on the shoulder one day and said, “Dude, it’s just a tulip bulb.” Seems like a quaint story until we remember all the websites that had no product, service or functionality that were so valuable ten years ago.

I would suggest that we consider the following:

Debts are not going to get paid back. Not the personal debts that are close to $2.5 trillion that Americans owe or the mortgages on properties that are not worth the loans or the national debt – in our country or in others. Some of this will take the form of tax payer revolts and some will take the form of people going on YouTube and challenging the banks but mostly it will occur by people simply no longer paying the loans.
The endgame for all the derivative assets and worthless loans on the books of financial institutions is nearer than we think. What is worth nothing will be acknowledged as being worth nothing.
Alternative ideas about money will begin to appear. There have been systems in the past were the value of money declined the longer it was held. There are systems now that derive value from time – time banks. What seem like wacky ideas will begin to seem sane as the wacky ideas that have passed for sanity are revealed as wacky.

So have I traded in my risk management bona fides to become a fortune teller? I’m not psychic and I don’t see dead people. All three of these events are occurring now. The tulip moment is upon us.

Microfinance and Risk

2009-08-17T16:34:00.000-05:00

There has been a drumbeat of increasing volume in the corridors of western businesses over the past thirty years about the nature of risk. Risk is bad; it needs to be mitigated, managed into submission or laid off on 3rd parties. Massive resources have been put into “loss databases” in an effort to create an actuarial database that would allow organizations to insure themselves against any and all negative occurrences. And yet, despite all this effort and cost we are in the midst of the greatest financial collapse the world has ever seen. None of the methodologies, none of the models and most certainly, none of the experts saw it coming. Yet, despite all this it is safe to say that the perception of risk has not changed in these companies. They still spend the same and in some cases, more resources in trying to anticipate all the negative events that could occur as though just a little more preparation would make them immune from the vagaries of life. They still focus on all the things that could go wrong.

Microfinance, on the other hand, approaches risk from a completely different perspective. In granting a loan at the local level it looks at risk from the point of view of “what needs to go right”. Loans are granted in the context of what would thrive rather than judging various projects from the standpoint of their likelihood of failure. Risk is embraced and managed as a central element of a successful venture.

The truth is that there is a great duality in most large corporations. Risk management groups work away at trying to identify hazards and uncertainties and the rest of the organization essentially ignores their efforts and engages in activities designed to increase profits rather than perfect products and services. Risk is embraced in the service of enhancing the stock price or the quarterly earnings. The means of exchange (money) becomes more important that what we exchange (products and services).

In the microfinance world, this model is turned on its head. Investments are made to support the improvement of products and services. Money is understood as a means of exchange that serves what it is that is exchanged. It would seem that there is a great deal to be learned (or more accurately, remembered) from the success of microfinance.

The Decline and Fall of the New York Times

2009-03-17T13:24:00.003-05:00

Last week everyone with an Internet connection had the opportunity to see John Stewart incinerate CNBC’s Jim Cramer on the Daily Show. During that program Mr. Stewart showed clips of Mr. Kramer talking about his famous “pump and dump” strategy with a young reporter – saying things that he said that he would never say on television. The show was full of those moments that rarely occur on television; an accurate and well researched analysis of the gap between what people know to be true and what they are willing (or paid) to talk about publically. Mr. Stewart comes by his reputation as a fearless satirist and, in this case, reporter honestly. He took on Tucker Carlson and Paul Begala on CNN several years ago on their show when he chastised them for not only not reporting the news but also obscuring it.

It is no wonder that people increasingly look to the Daily Show and Internet sites for information about what is going on in the world. This is not a new story, it is a story of a decline in the news media that has been going on for some time and shows no signs of abating. It is as though we are watching a meltdown similar to what we have been experiencing in the financial sector. Our mainstream press, whether it is network news, cable news or our major daily newspapers, continue to obscure information that is vital to understanding what is going on in the world and, as a consequence, making it more difficult to fashion solutions.

Today’s editorial in the New York Times about the AIG bonuses compounds a problem that all of their reporters and particularly one of their columnists, Tom Friedman have created. The editorial continues to promote the myth that “taxpayers” are somehow funding the AIG bailout. They are not. The $170 billion that has gone to AIG is the result of a series of loans from the Federal Reserve. Essentially the Fed used the device of the loans to channel money to their stockholders (the banks) so they wouldn’t default. Whether this is good or bad can’t really be understood because it is not reported. There is no taxpayer money in the Federal Reserve.

Let me digress for a moment to address what some economists may insist makes that last statement not true. The Federal Reserve does receive interest payments on the money that it loans to the US government and those interest payments are funded by tax revenues. But to insist that these are still taxpayer dollars is like saying that somehow there is an extension of ownership of any money that is paid in interest. It would mean that the interest that you pay to the bank for your credit card purchases is somehow still your money. It’s a specious argument.

Americans are not taught how their financial system works in school. I have done a brief survey of the high school curriculums of some public and private high schools in New York City and discovered that there does not seem to be any information on the subject. There is some reference to President Andrew Jackson’s railing about central banks but it is relegated to a brief mention with no connection to the organization of our monetary system and the creation of money.

That said, it is possible to find a great deal of information on the Internet. To be sure, a good deal of it is written in bold capital letters and comes in the form of conspiracy theories about the Illuminati and the eleven families who control everything in the world. But a good portion of it is very straightforward. Americans are educating themselves about the Federal Reserve, its status as a private corporation owned by the banks and its responsibility to manage the monetary system and create the very currency that we use as a means of exchange. Increasingly this information is making its way onto public television stations (albeit very slowly). My sense is that we are very close to a tipping point.

In the moment the news media and the political class are making hay by attacking the people who received the bonus money at AIG and Merrill Lynch. That’s fine. It makes no sense to give out bonuses when the company is losing money no matter where it comes from. The excuse that it is necessary to retain all the top talent that either actively engineered the current mess or stood by and watched it happen has a very hollow ring. Where exactly is all this top talent going to go? So, by all means let’s get Andrew Cuomo (New York State Attorney General) and others to grab these folks by the scruff of the neck and give them a good shake. Put some in prison as well. But even if that happens it will not change one iota of the system that created the problem and it will not move us on a path to recovery.

The only way we are going to get that is to understand how our system works and the news media seems to be working overtime to ensure that that doesn’t happen. It is a fool’s errand. They are appealing to the same instincts that cause people to watch Jerry Springer and Dr. Phil. The Roman Circus concept works when people didn’t have access to accurate information. That’s no longer the case.

It is hard to imagine that we may not have a New York Times in the future but newspapers are folding at a rapid rate. They are losing advertisers because people aren’t buying them and people aren’t buying them because they increasingly understand that they don’t contain much news.

The Longest War

2009-03-10T14:49:00.001-05:00

Several weeks ago the New York Times published and article on the number of states that were actively engaged in repealing the death penalty. Apparently it is very expensive to kill someone (some estimates range as high as nearly $2 million) and cash strapped states are discovering lawmakers would rather fill potholes than exercise righteousness in the service of the ultimate penalty. And then there is also the increasing number of false convictions; of the 232 convictions overturned by the Innocence Project, 17 spent time on death row. The advance of technology has resulted in many states reconsidering the irrevocable choice of putting someone to death.

In adding to the discussion of the balance between cost and punishment, the leader in The Economist this week addressed the failure of the War on Drugs. While the terminology of war in this “war on…” was created during the Nixon administration (some say in response to Lyndon Johnson’s War on Poverty), The Economist dates the assault on illegal drugs and their users to have begun during an international conference in Shanghai in 1909. In the United States the passage of the Harrison Act in 1914, making the use of cocaine illegal, is usually seen as this nation’s official date for the movement to make a certain class of drugs illegal. In any event, the effort to criminalize drugs has a long, costly and mostly ineffective history. Now it seems that the financial crisis is causing some to reconsider whether or not all the money that we spend is worth the result.

There has always been an element of hypocrisy in our drug laws. While we make cocaine, heroin, marijuana and other drugs illegal we allow the smoking of tobacco and, with the exception of 13 years in the 1920’s and early 30’s, the consumption of alcohol. The effect of these two legalized drugs on their users, their families and, in the case of tobacco, the victims of second hand smoke has been catastrophic. Both damage the health of the people who use them and people who are impaired by alcohol do physical damage to others, either with their fists or with automobiles. Add to that the increasing abuse of prescription drugs and the pretzel logic of what is and is not an acceptable drug becomes less and less obvious. Explaining to a young teenager the rationale of why some behavior is sanctioned and others not is a challenge.

But now we are entering a time when decisions are being driven more by economic realities than political ideologies. Some would say that applying this newfound pragmatism to the prosecution of drug offenses is cynical. Is it that we have decided that we can’t afford the maintenance of societal standards? Or perhaps we have moved into a different context; one in which we need to take a second look at our conflicted moral code about substances that alter the sober mind.

We come from a Calvinist heritage in the United States. Although some of the first Europeans to arrive on these shores were fleeing religious persecution they were more than happy to inflict their own brand of morally-based restrictions on each other and ultimately the culture at large. We have lived through restrictions on who can marry, who can have sex (including meticulous detail on the acceptable and not acceptable acts), who can vote and who can ride on a bus. These restrictions have been based on race, gender and sexual orientation and many of them no longer exist in the form of legislative prohibitions. It would seem reasonable that we are on the verge of moving toward a more permissive attitude towards drugs.

Should this happen, should we actually legalize drugs, monitor and mange their growth, distribution and sale (along with the revenue from taxing them like alcohol and cigarettes) we would take a radical step in reducing the incarceration rates in the United States. The criminal enterprises that have been a plague on the world’s developing nations would be robbed of a source of income vital to their existence. So many resources that are currently committed to this endless struggle would be freed up for other pressing needs.

But what would the legalization of drugs do to our social fabric. It is reasonable to assume that more people would take drugs. It may also be reasonable to assume that there would be an increase in the number of people who suffer from addiction and whose lives would take a turn for the worse. That has always been the dilemma of legalizing drugs; how many more would be harmed than helped in the service of removing the taboo and the criminal penalties?

The context of the economic crisis is causing all of us to rethink our values and our behavior. The economics of our country and the world will reflect the decisions of people about the ways in which they spend their money. Policy makers who are valiantly trying to re-inflate the debt bubble would be wise to take that into account. There are fundamental changes afoot that have nothing to do with toxic assets, derivatives and the nationalization of banks.

It could be that we are about to embark on the construction of a society that has as one of its basic tenants the idea of individual responsibility. The nature or content of that responsibility will be increasingly be defined by the individual rather than some ideology. It is not based on a moralistic set of rules but rather an ethical framework in which people choose to do the right thing at the right time in the context of their own experience.

That’s a dangerous idea for a bureaucracy. That’s a dangerous idea for a morality that is based on rules developed by a small cadre and inflicted on the larger group. But increasingly we are discovering that people make their own decisions regardless of someone else’s idea of what they should do. Perhaps we are at a point in time where the choice to alter one’s mental and emotional process should be in the hands of the individual. That doesn’t mean that people are allowed to be less responsible; quite the contrary.

In any event, the bottom line on this longest of all wars is that it has not been won. The casualties are in the millions and the cost is in the hundreds of billions. This is not a war that we can afford to fight with police, guns, judges and jails. This is more a struggle for the human soul and that is an effort that every individual must take on themselves.

Defining Insanity

2009-03-05T14:37:00.002-05:00

Many years ago when I was beginning my first career in the mental health field and taking as many courses in special education and psychology as I could manage, I began to consider the definition of insanity. It seemed to me that the line between those considered sane and those considered not moved back and forth quite a bit through history. I recall reading Arthur Miller’s The Crucible in which he used the Salem witch trials and the approved murder of people determined to be evil as an analogy for the mass hysteria of the McCarthy era. I saw one of the first stage adaptations of Kesey’s One Flew Over the Cuckoo’s Nest in which insanity seemed to be defined as both rebelling and conforming with the only sane option being observing and creating one’s own reality. Some time later, in the middle of a heated discussion in which I was arguing against the drastic increase in kidney damaging psychotropic drugs for one of my patients I was told by the Deputy Director of the hospital that the Department of Mental Hygiene was an agency of social control and if I didn’t like it I should get out. And so I did.

The subject of the societal definition of insanity seems to be one that we should consider again now. Almost every day we are confronted with another piece of news about the collapse of the financial system and a new explanation about how it has occurred. Eastern Europe is demonstrating behavior equivalent to those who took out sub-prime mortgages. Switzerland may be on the brink. There was a story in the UK’s Daily Telegraph last week about a secret EC document that estimates that “impaired assets” may make up 44% of EU bank balance sheets. We have all been told to brace for a second wave of residential mortgage defaults and that commercial property will be the next asset to deflate.

Each time we hear one of these stories the mind struggles to put it in context. It’s getting more difficult. We seem to be in some strange holding pattern where everyone knows that things are going to get worse, some of our government leaders are telling us things are going to get worse but no one wants to take the steps that would move the process into greater pain than is being experienced now – even though we all know it is coming and unavoidable.

Let’s consider the Obama administration’s effort to deal with the financial system and the housing crisis. We really only know the number for the financial system program – somewhere in the neighborhood of $2.5 trillion. If AIG is any measure of what will be done, banks will be given more money (through a variety of loans and/or equity investments) to provide them with the reserves necessary for them to stay solvent. These reserve requirements are being raised as the result of defaults on loans and/or collateral requirements that result from requirements in derivative contracts. So we are keeping the patient alive through transfusions but we haven’t yet dealt with the multiple bullet wounds that keep bleeding.

For homeowners, if they can meet the requirements and if their lender voluntarily wants to negotiate they can get their 20 year loans turned into 30 and 40 year loans that will lower their monthly payments and potentially their interest rates. But they will still be paying the full amount of their mortgages; an amount that their houses are no longer worth. In essence, this is another way of pumping money into the financial system without requiring the banks to write down the mortgage loans to the diminished value of the houses.

We are still pretending that things are worth what we know they are not worth. For all the talk of good bank/bad bank (a scenario in which the band bank would take all the “toxic assets”) no one really wants to move on that front because valuing the “toxic assets” would likely result in a calamitous collapse. A recent PBS sponsored analysis revealed that a middle of the pack mortgage backed security was worth 1 to 1 ½ cents on the dollar. Other reports have suggested that $500 trillion in derivatives in the global market are worth about $.20 on the dollar – that a $400 trillion write-down.

Timing is everything. Confronting a fragile patient with harsh realities could lead to a psychotic break. On the other hand, prolonging the agony by medicating the patient into a somnambulant state just delays the inevitable and can prolong recovery. The fundamental problem is that we can’t get on with rebuilding what we don’t recognize as being broken. The new definition of sanity that has to emerge begins with acknowledging the lunacy that we have collectively participated in and accepting the consequences. We need to move a little faster and get on with it.

The Risk of Demagogues

2009-03-01T14:29:00.001-05:00

The new CIA Director, Leon Panetta, has a new item in his daily briefing to the President. It is a list of actual and potential locations of civil unrest resulting from the economic crisis. It is a list that is growing and shows no signs of getting shorter any time soon. The summer of 2008 saw food riots in Africa and Asia. Later in the year China began to experience what the government calls “mass incidents” resulting from factory closings and the ensuing financial hardships. The images of six days of violent protest in Greece were seen around the world and reports of demonstrations in France, Ireland, Iceland, Italy, Latvia, Bulgaria and Russia in Europe were complimented with similar events in Haiti and Bolivia in the Americas.

The weather will start to get warmer in the northern hemisphere in the next several months and it would be foolish to think that we won’t experience more demonstrations and breakdowns in civil society as we move through the summer. Even the most optimistic economic pundits acknowledge that 2009 is a year when things will get worse. People who have grown up with an expectation of continued economic expansion and the lifestyle that accompanies it are going through a period of intense shock. The awareness that comes with understanding how our monetary system actually works will be sporadically punctuated with intense rage. It is the channeling of this rage that presents the greatest challenge to our civil societies.

There are those who believe that they have figured out what went wrong and have identified the culprits. Increasingly these villains are deemed to be those who took out mortgages that they could not afford. Even the President of the United States has separated them from others who, although they can’t pay their mortgages either, somehow will manage to qualify for government help – assuming that they don’t loose their jobs between now and when the programs to save them are put into effect.

Certainly there are hapless souls who didn’t know what they were getting into. Certainly there are others who knew exactly what they were getting into and didn’t care. The vast majority of these new homeowners, I would suggest, believed what the supposedly smartest people were telling them; housing prices would continue to go up and they could refinance their way into continued homeownership forever. We like to forget the context for how these loans were marketed and the delusional system that virtually everyone bought into.

But the danger that we all face comes from the new cadre of “smart people” who want to replace the old set of “smart people”. These new folks would have us believe that if we blame the right group and demand that they are made to suffer without the rest of us having to pay, somehow this will represent justice and all will be right in the world as a result. In the short term these new purveyors of the truth do more damage to the people who line up next to them and wag their fingers in unison than they do to the people who they blame. After all, if you have lost your home and your family is in despair, how much more can be done to you? But if you are casting about for a reason that your bank account and future prosperity have been damaged beyond repair, finding a villain only serves the purpose of ceasing to understand the dynamics of what is really happening.

We are all living through the unraveling of an economic system. In a debt based monetary system there is always a tension between the ability of an economy to grow fast enough to generate enough money to pay the interest on the debt. Since economies grow in a linear fashion and interest compounds, growth can never accommodate the cost of this so-called capital. Throughout history we have had bubbles. A few hundred years ago people in Holland decided that tulip bulbs had extraordinary value. A decade ago we all decided that websites with no discernable product or service were worth their weight in gold. Bubbles are how we have dealt with the disparity between economic growth and the burden of interest.

This time, however, we have outdone ourselves. Instead of inflating an asset like a tulip bulb or a website we have inflated the value of securities that have no underlying value (derivatives) and created a complexity of interdependent relationships that we can only discern as they begin to fall apart and fail. And we have extended it from a component of a national economy to the fundamentals of the global economy.

The responses to the events of the past six months have been fairly predictable. The system is trying to save itself. We are trying to bring more debt to a system that is collapsing because of the burden of debt. We are trying to re-inflate the bubble. For all our efforts we are really doing nothing more than giving morphine to a cancer patient. For all the discussion about Keynes’s and Friedman’s approach to the economics of capitalism it must be becoming apparent that the kind of system that we will end up with when the chaos begins to subside will not resemble anything like what we have experienced over the past 100 years.

What’s essential, it seem to me, is that we all continue to educate ourselves about our monetary system in as dispassionate manner as possible. We all want an answer, an end to the pain and suffering – if not for the other guy at least for ourselves. I would suggest that we won’t get there without walking down some blind alleys and without learning more than we may want to know about our own folly. Those who give up their contribution to a better understanding in the service of a demagogue who provides someone to blame simply distract from an inevitable process. There is no magic bullet. There is no new economic “ism” already formed out there hidden from view that will miraculously appear and solve all our problems.

That I would suggest is the good news. We are on the precipice of a remarkable point in human civilization. We must not give up and take the intellectually and emotionally dishonest route of a solution based on blame.

As Walt Kelly once wrote “We are confronted with insurmountable opportunities”.

Stress, Growth and the Economics of the Future

2009-02-22T14:38:00.001-05:00

I was reminded recently of a story I heard many years ago. A patient goes to the doctor for his annual checkup. The doctor does the examination and conducts the usual tests. He goes and gets the results and when he returns to the examination room he asks the patient “Have you been under any stress lately?”

“Stress?” the patient says, “Stress would be a relief!”

That’s how it seems these days. The financial reality of the world’s economies defies comprehension. We have created a concept of wealth based on a delusional system. Derivatives, those contracts that guaranteed payment based on debts associated with underlying assets had a face value last September of $1,300 trillion, completely dwarfing the value of those underlying assets – and that was before the crash.

We can’t seem to get enough information about how everything is collapsing; it’s like watching the spread of the plague in real time. We have taken what is a means of exchange and decided that it has more value than what we exchange. In addition to all that, we have a global population that is already in “overshoot” – it cannot be supported by the global ecosystem and it is projected to increase by 40% (6.6 billion to 9.2 billion) in a little over four decades.

This past week we heard Republicans (Senator Lindsey Graham and even Alan Greenspan) begin to suggest that the nationalization of major banks is the right thing to do. Paul Vlocker and George Soros described the current crisis as as bad or worse than the Great Depression. No one thinks we have found the bottom. And now we are seeing polls that suggest that the American people are reaching new levels of fear and distrust of the future. Stress, it would seem, really would be a relief.

But underlying all the policies and stimuli and philosophies and principals exists something that we all seem to be ignoring. Things have changed in our world and they are not going to change back. We have lived on credit and that credit, that consumer consumption, has driven over 60% of our economy. The bottom has dropped out of that consumption model. Pouring money into the system, to the degree it will create jobs will boost spending, but nowhere near to the levels of the recent past. That economic model is over and we have not spent a whole lot of time thinking about what is going to replace it.

All of the sober prognosticators seem to know this. There is talk about a long period of stagnant economic activity when (and if) we can stabilize the system. No one is really talking about what that looks like, but there continues to be a mantra that we must restore growth, albeit anemic growth. When one looks at the level of global resource depletion and the current level of overpopulation one has to ask whether or not the goal of returning to a growth model is probable or even possible.

There are some folks out there who advocate a steady-state or no-growth economy. This would be a structure where companies produced sustainable products and services. But the underpinnings of such a model require a high degree of central management and an equalization of wealth among the populace – essentially non-starters from a policy and political perspective.

But we might want to consider that something else is happening while the policies are being debated. People are changing their behavior. It may be true that if the stimulus creates or retains several million jobs that those people will spend the money they earn, but it would seem very likely that they will only spend it on food, shelter and essential clothing. Given the level of pain that we are experiencing and will experience for some time, changing that behavior back to a looser more positive mindset could take a generation. It wasn’t until the 1980’s that we began to shake of the emotional impact of the Great Depression.

So we don’t know what our new economic model will be but isn’t it interesting that ordinary people will actually be the ones who determine how it will function. Economics, it would seem to me is another discipline in which we define how we relate to each other. From a materialistic perspective it seems very central but from a human perspective it is similar to how we view science, healthcare, sports, art, politics or any other discipline. They are all reflections of what we believe to be real and what we think has value. Change that context and what has value shifts and all of these disciplines change.