Friday, February 26, 2016

Institutional Failure

A couple of months ago I saw The Big Short, and it had a powerful effect on me.  Although the heroes of the tale, Steve Eisman (played by Steve Carrell) and Michael Burry (Christian Bale), had personality problems which I hope that I do not share, they were hard-headed guys who didn't trust what anyone else said, and who therefore saw that something was rotten in Denmark when everyone else continued to cut larger and larger slices of cheese.  I envied them, too, not for the money they made, but simply because they were betting on real time events, and the results proved that they had been right--something that can never happen for those of us who write about the past.  I decided to read the book as well, and I finished last week.  It reinforced the lessons of the film, and left me more convinced than ever that virtually all the major institutions of our society share the same rot, which is making it impossible for them to function for the common good, and threatening total collapse on many fronts.  I saw this happening in our colleges and universities during my 37-year career, and it is increasingly clear that what I saw was not exceptional.

I shall not attempt to retell the story of The Big Short, but rather focus on a number of almost random remarks that  pop up here and there through the text.  One such remark came from Charlie Ledley, one of two small-scale traders who had specialized in finding long shots that had a much better chance of paying off than their price seemed to indicate.  He and his partner Jamie Mai, believed "that public financia lmarkets lacked investors with an interest in the big picture.  U.S. stock market guys made decisions within the U.S. stock market; Japanese bond market guys made decisions within the Japanese bond markets, and so on. "There are actually people who do nothing but invest in European mid-cap health care debt,' said Charlie. 'I don't think the problem is specific to finance.  I think that parochialism is common to modern intellectual life. There is no attempt to integrate."  Hmmm.

The tendency towards specialization has wrecked modern intellectual life, especially in the humanities and social sciences.  In my own field of history, and also in literature, there is no expectation that scholars will have any talent for taking a very long view, or understanding how the present actually differs from various periods in the past.   That is why survey courses, which used to be the province of the most distinguished faculty members, are now more likely to be taught by adjuncts.      Because such skills are nearly ruled out of academia, students at elite institutions have no sense of how what is happening today fits into the broader development of western and world civilization.   Economics students, I suspect, learn little about the bubbles and crashes of centuries past, and thus failed to recognize the signs when they recurred.  And that is having consequences potentially as great as the financial crisis of 2007-8.

A second broad point concerns the ways in which the untrammeled free market, the god of our economics departments, business schools, and political parties, has utterly transformed institutions that once served a useful purpose into parasites.  Steve Eisman, one of the main characters in the book, began with the realization that many subprime home loans were going to default at a predictable moment, and found a way to bet against them.  But he followed that insight up the economic food chain, shorting the stock of mortgage originators, home builders, and even the ratings agencies that were certifying bonds based on those mortgages.   And then, reaching the top of the pyramid, he focused on the big banks themselves--Goldman Sachs, Morgan Stanley, Citigroup, and the rest.  "One of the reasons Wall Street had cooked up this new industry called structured finance," Lewis writes almost offhandedly, "was that its old-fashioned business was every day less profitable.  The profits in stockbroking, along with those in the more conventional sorts of bond broking, had been squashed by Internet competition.  The minute the market stopped buying subprime mortgage bonds and CDOs [collateralized debt obligations] backed by subprime mortgage bonds, the investment banks were in trouble."  And because the banks were now traders in their own right, the role of bond salesmen, everyone now understands, isn't to help both sides of a transaction to benefit, but rather "to screw their customers."  The big banks don't want to help industrial and commercial firms establish and maintain their profit streams, they want to build up their own, largely by running a rigged casino.

I could spend a lot of time coming up with analogs for this behavior, but one would suffice: the role of big pharma.  About 150 years ago, Louis Pasteur, Paul Ehrlich, Sir Alexander Fleming and a few others discovered means of preventing or curing often fatal infectious diseases, an extraordinary breakthrough that has saved many millions of lives. The world now desperately needs new antibiotics, but the big drug firms, who have all the money they need to look for them, aren't very interested.  Rather than find drugs, much less vaccines, that would cure or prevent diseases, they prefer developing treatments for chronic conditions like indigestion, or simply pain.  That is how they have managed to hook hundreds of thousands of Americans on powerful opioids.  Hundreds of those Americans, who switched to cheaper, more accessible heroin, are now dying of overdoses every day, but hardly anyone has had the courage to focus on the real cause of this new, often fatal epidemic.   Again, something similar has happened in leading colleges or universities.  They have become gateways into the upper reaches of American society whose endowments have become hedge funds.  Almost none of them have anyone looking seriously at their students' educational experience, much less thinking of ways to improve it.  They are interested, of course, in moving some of their education on line, where they will no longer have to pay live professors to provide it, and they have vastly expanded the role of adjuncts to save money.

A third major lessons involves the internal workings of the big banks.  Again and again, Lewis's subjects discover, no one, least of all the CEOs, seems to have any real idea of what the assets their firms are creating are really worth, or even what was behind them.  This is another endemic problem in our society, on related to, but not exactly the same as, the Peter principle, which stated almost half a century ago that in hierarchies, people rise to their level of incompetence.  My variation on this theme is that at some point in any hierarchy--firm, university, hospital, or heaven help us, government--men and women reach a point at which they are no longer paid to think.  University presidents, Wall Street CEOs, and many others, doubtless, are prize animals, led around by their handlers from fair to fair to assure everyone that all is well and maintain friendly relations with other power centers.  Having grasped what was happening with subprimes, Ledley and Mai assumed for a long time that the movers and shakers in the big banks knew what they did and were using these instruments to fleece their customers. Eventually they realized that that was wrong.  "The big Wall Street firms," Lewis writes, "seemingly so shrewd and self-interested, had somehow become the dumb money. The people who ran them did not understand their own businesses, and their regulators obviously knew even less.  Charlie and Jamie had always assumed that there was some grown-up in charge of the financial system, whom they had never met; now, they saw there was not."  Many of us, I think, have had similar fantasies about various key sectors of our society, including the one that we work in ourselves.  Another interesting symptom that emerges repeatedly through the book is the willingness of Wall Street operatives to joke about the absurdity and idiocy of what was happening.  I have seen the same kind of smirking on the faces of relatively traditional historians talking about the work of their newer colleagues many times--but they did not recognize it as a serious problem, until one day they woke up to find themselves intellectually isolated in their profession.  I have also seen that smirk on the faces of doctors talking about some of the new SOPs in their profession.  It's never a good sign.

The depth of the intellectual and moral rot at the upper reaches of our society became even more apparent after the crash.  Although Burry, Eisman and the rest reaped huge financial rewards for having seen it coming, they did not win any respect or admiration from their peers, or even from the investors whose money they managed.  Burry had indeed been battling for two years with his investors over his bet against subprimes, which did not seem to them to be likely to pay off, and only the force of his personality allowed him to stick with it until it paid off.  (That is another scene that I have played regarding the content of some of my books, but that's a story for another time.)  Meanwhile, Bury saw well-connected people who had gone with the flow appearing on television and explaining falsely that they had seen the crash coming.  I have seen the same thing in two pundits--one a journalist, the other an academic--who cheered loudly for the Iraq war but no longer hesitate to pronounce it a disaster without the faintest hint of an apology.  Both, of course, still work at the highest levels of their professions.  "What had happened," Lewis writes of Bury, "was that he had been right, the world had been wrong, and the world hated him for it."

Last but hardly least, as Lewis explains in detail in his last few pages, the consequences of the second-greatest crash in American history have been minimal.  The government, of course, bailed out all the major players in the crisis, and despite Dodd-Frank, the culture of the big banks has not changed.  (I have had occasion to discuss that once or twice here.)  "The reason that American financial culture was so difficult to change--the reason the political process would prove so slow to force change upon it, even after the subprime mortgage catastrophe--was that it had taken so long to create, and its assumptions had become so deeply embedded."  Millions of Americans lost their jobs, their homes, and their net worth, but Wall Street used its power to convince the powers that be--led by Barack Obama--that nothing too fundamental was wrong.  They also took care to put a six-figure sum into the pocket of Hillary Clinton, the heir presumptive to the throne, as soon as she stepped down as Secretary of State.

And that leads me, at long last, to the institution that seems closest to complete failure, our political system.  The pretense that it serves the needs of the public, obviously, has worn very thin among the people of the United States, which is why Donald Trump leads the Republican field and Bernie Sanders has fought his way to rough parity with Hillary Clinton.  The establishment in both parties is peddling subprime bonds.  The Republicans claim that making the rich yet richer will help the rest of us, while Clinton argues that prejudice against women, minorities and gays is more important than economic inequality.  Bernie Sanders--truly a man from another era--has proclaimed that the establishment has no clothes, and the message is resonating, particularly among the young, who are being left out of our economic growth.   Yet how well he can do in the campaign--or, for that matter, in the White House--remains a very open question.  The intellectual rot throughout our society is very, very deep, and needs to be cleared away to allow healthy plants to flourish.  That will take a long time.

My own profession must take a huge part of the blame for this.  The men and women who are paid to research, think, and teach have a unique responsibility to our society: to use that time well for themselves, their students, and the world at large.  A few still do, but the leaders in the humanities and social sciences have taken a different path.  Their work, basically, feeds their own egos, helps to create an alternative universe on campuses, and often serves the needs of powerful interests.   That leaves a gap which no other institution can fill.  For several decades I kept an older tradition alive in my books and classes, and for a dozen years I've tried to do the same here.  I am not alone, but it will be a very long time before the Enlightenment tradition can really be revived.


ed boyle said...

Reality is ignored by the generations used to abstractions. As a civilization progresses it goes from primitive beliefs to abstraction. Current theories of physics like string theory are unproveable, akin to religion. Economics is, like psychology, pure theoretical nonsense. Everything going on in the political, social, economic, cultural environment is opinion based pseudoreligious theories cooked up with higher mathematical models to make it look scientifically respectable. Look behind the theory and you find interest groups, not objective rational, disinterested research. At this point in time in a civilization comes collapse as reality neccessarily takes over. In this case we have the idea that permanent economic growth in a limited world can provide endless satisfaction to an enlightened democratic citizenry. Obviously the world was not created for bipedal primates by a benevolent bearded godhead. Our enlightenment forefathers turned atheists forgot however to take into account this inconvenient fact into their political, economic and social theories. Be fruitful and multiply and dominate the earth remained our creed. Now we are reaping the whirlwind in terms of resource depletion, mssive overpopulation, climate change. A theory is always just a limited subset of a greater, undiscovered reality. Newton's laws hits its limits at light speed. Einstein noticed the problem and filled a theoretical gap. Gaian total systems theory and corresponding economics theory based on physics, energy and resource availability fills the current gap. It will take however a complete global economic collapse with war, famine, climate collapse to help these theories to standard doctrine instead of edge theories. The spiral of progress uses previous technique, such as mathematical modeling, to develop new views of reality. We must learn to limit our view of ourselves in the universe or die in the attempt to remain a demigod on earth.Rational science is not an excuse to fake evidence for our dream of what we want reality to be but rather a technique of discovery of objective reality. Generational theory states that just before a crisis objective reality is in the back seat and ego in the front seat. Whoever can control reality more wins and makes the new rules which lead directly to the next crisis due to the tendency of homo homo sapiens towards linear ad absurdum thought processes. The generational theory is embedded within a larger civilzational process of hundreds of years. USA took over from Eurasia slowly starting 400 years ago championing materialistic growth consumerist democracy. Pursuit of happiness is humanism pure. 90% less fish and wildlife since 1900 asks whose happiness. Fat, lazy, middle class i dustrial, global human consumers. How long till we've eaten our last seed grain?

Steven Winsor said...

Well said, David. Wish Milton Friedman were alive to try to make some sense of it all. You've done a remarkable job here (so sayeth this Republican). I believe the rot is endemic. People in this country, whether Republican, Democrat or Independent feel it. We know something is wrong.

Hence Donald Trump and Bernie Sanders taking populism to new heights. Trump is seen as a decision-maker, a guy who has the guts and balls to make the changes needed. And Sanders speaks from the socialist end of things as an agent of change. I've been watching presidential campaigns since Nixon-Kennedy in 1960...and this year's is the craziest of them all.

Bozon said...

It is great to see you, once again, go into issues other than party politics from a predominantly Democratic perspective, and into issues nearer to my concerns regarding underlying problems (myself a greedy choir to preach to, if you will).

You call these institutional failures. Great term.

I have called them political structural problems, at times, which to me means much the same kind of thing, really, or similar.

My view, though, is that such problems go back to before the founding, and on this question, I do not know if there is much common ground between us.

Still, bravo. Bravo.

Best post I have read as an eager choir.

all the best

Gloucon X said...

"Government is not the solution to our problem, government is the problem." -Ronald Reagan 1981

"the era of big government is over" -Bill Clinton 1996

Those marching orders, given to us by both corporate-owned parties, have yet to be countermanded. They crowned the untrammeled free market King and appointed our government as his servant. When he screwed up in 2008, of course the corporate parties agreed that nothing too fundamental was wrong, in fact, they continued to hail the King. The assumption that the untrammeled free market had the divine right of unquestioned rule over us had become so deeply embedded.

So now the people no longer believe that our political system serves the needs of the public. But with two corporate owned parties, and a corporate owned press, no one is there to explain to them that the untrammeled free market serves the needs of powerful corporate interests and doesn’t care at all about the needs of the people. The two parties they voted for created a plutocracy, a government of, by, and for the wealthy--why are most citizens so surprised that it doesn’t serve their needs?

CrocodileChuck said...


A magisterial essay.

One thing: re: the Michael Lewis book, read this [he completely missed it]

[how a US$1.4T sub prime bubble became $14T in losses to the wider economy]: LEVERAGE

Bozon said...

Forgive me for making another comment here rather than on my site.

One of the interesting things, to me, about the mortgage backed housing bubble, is that this developing bubble in housing prices was not really difficult to see: it went on for years starting I guess in the late 1990s, early 2000s, it was obviously somewhat suspect based on low rates and very loose lending practices, no money down, inflated appraisal valuations, it was filled with newbie real estate investors buying and flipping properties, and it was national in scope. I was puzzled that other people, people whom I considered savvy people, did not see it developing as such.

Of course, i had not studied the financial underpinnings of the boom, securitization of mortgages, but it was clear that there was a large bubble developing for some reason or other.

I even warned people that they weren't going to like it when it unravelled. It, depressed properties with big mortgages, was not going to be like a stock you could simply sell, or a liquid investment you could also readily hedge.

all the best

Patrick Bowman said...

On the subject of the big picture, historically: The Universal City Red Line station, part of the greater Los Angeles Metro system, is paved with tiles telling how Los Angeles and California came to be. One part mentions how the arriving Spaniards thought the local Gabrieleños spoiled their children: "The padres complained that the natives treated their children like idols, because they lacked discipline."

Was that a cultural standard, or an accident of history? Were the locals recovering from a recent war, famine, or other Crisis that made children prized and coddled? Or had there recently been improved welfare that allowed them to indulge and protect them? Nobody seems to consider such possibilities, instead dragging the observation into an indictment of colonialism or evidence of racism or whatever is seen as the Real Problem With Those Europeans.

Because that's what they study, or know, or believe.

Perhaps provincialism is cyclical - people concentrate their focus until everyone knows everything possible about their personal infinitesimals. Then either society implodes, or someone comes along to integrate the parts into a useful whole.

Implosion seems more likely, though.

Rupert Chapman said...

You are spot on as regards the failure to see the big picture. Those in the US and commenting on the situation there are treating this as an American problem, but it isn't. It's much bigger than that. In the UK, the Labour Party has fractured, with the general membership electing Jeremy Corbyn leader, over the heads of the Blairite/Brownite Members of Parliament, who haven't yet grasped that they are nationally unelectable due to the catastrophic adventure in Iraq. The Conservatives are similarly fractured, having lost the bulk of their right-wing voters to the United Kingdom Independence Party over membership in the European Union. And in Scotland a populist uprising has seen the Scottish Nationalist Party virtually wipe out the vote for the Conservatives, the Labour Party, and the Liberal-Democrats, in spite of the fact that it is clear that the majority of Scots don't support the main plank of the SNP, namely, Scottish independence. Similarly, in Greece, we see the rise of Syriza on the left and Golden Dawn on the far right. I'm sure that there are other, similar, examples, with which I'm less familiar (perhaps the continued rise of the far right parties in Israel?). This is a world-wide problem, and if you are right about the generational cycles of history, then it is likely that we are at one of those generational turning points which is going to produce a restructuring, but not, this time, on a national, American, scale, rather, on a world scale.

You are also spot on with the failure of people to see the past. As an archaeologist, I deal every day in long-term history, tens of thousands of years, not tens. The other evening there was little of merit on television, so I persuaded my thirty-year-old son to watch The Maltese Falcon with me. He had never seen a Bogart film before and was mesmerized. It has long been a trivial grump of mine that the lists of 'one hundred best films' which one sees rarely include any film more than ten years old, because most people live so much in the present, are so ignorant of the past, that they know nothing of even the popular culture of eras before their own, let alone of the major events. This short-termism dooms us to repeat past mistakes. Great leaders of the past were fully aware of the past, and used it so far as one can, to guide their actions away from the pitfalls.

Bruce Wilder said...

The architects of the domestic and international economic systems launched circa 1945, which systems have now passed their allotted three score and ten, had the experience of political and economic systems breaking down catastrophically as well as the grand examples of Progressive institution building. In some ways, they also had in hand some great advantages in that the U.S. was self-sufficient and more advanced technologically and economically than the rest of the world -- economically and ideologically, it was well-suited to be an anchor for a world system, well-equipped to provide the stabilizing counter-weights needed for leadership, if it could overcome its own isolationist impulses.
We don't have architects in our current elite. Through the entire second half of the cycle that began in 1945 and passed its major inflection point in 1981, the U.S. has been dismantling those systems, disinvesting from those structures. The two great political Parties cooperated in that task of taking apart the New Deal and the International Order: one became a wrecking crew, the other a salvage operation. Their experience is that no matter how stupid their choices, the consequences, at least for themselves, usually turn out OK if not terrific.

Particularly, for the major-league capitalists, the period since 1980 has marked an easy life. Disinvestment is great: you own a house, you raise the rent, you cut back on the maintenance -- your income increases, and despite all you've done wrong, the property appreciates in value, because interest rates decline. The people renting from you aren't doing that well, but, hey, who cares about the losers?
Now, we have a billionaire running for President -- never held office. Having inherited wealth, he's passed thru this period, flush with cash, his wealth increasing almost despite his questionable business decision-making, and he thinks he understands how the world works and the he, himself, must be a genius because his leaky boat has risen on the tide he thinks he commanded to come in.
We don't have the experience of the catastrophe. Or at least our elites do not. The catastrophes caused by the Clintons, Bushes and Obamas have mostly happened to other people, people far away or far down, and those responsible have never been called to account.
Interesting times.