Sunday, January 11, 2009

Supercapitalism run amok

It's fun to fulminate about the folly of Wall Street CEOs who ran their firms -- and the economy -- into the ground. But clearly something larger than individual stupidity was in play.

Take Robert Rubin - plainly one of the best financial minds of our time, who did nothing to help steer Citi away from the cliff's edge. Some may find his valedictory mea culpa a bit lacking in the 'mea' and 'culpa' departments:
My great regret is that I and so many of us who have been involved in this industry for so long did not recognize the serious possibility of the extreme circumstances that the financial system faces today. Clearly, there is a great deal of work that needs to go into understanding exactly what led to this situation and what changes, regulatory and otherwise, must now be implemented to reduce systemic risk and protect consumers.
In fact I think this is a balanced statement - accepting a measure of blame for lack of foresight while focusing on the responsibility now to figure out what went wrong and fix it. As Rubin suggests, there's a complex causal chain to unravel. Links on that chain include metastasized lobbyist influence, botched regulatory reform, and skewed incentives to take on undue risk.

One potentially useful tool for the postmortem is Robert Reich's Supercapitalism (2007) -- though the market meltdown demands some modification, I think, of Reich's central premise. According to Reich, it's relentless global competition among businesses, much more than right wing policy, that has driven the erosion of middle class prosperity, security and opportunity over the past thirty-odd years. Reich portrays a kind of extreme Darwinism that leads corporations to compete as relentlessly in their lobbying efforts as they do on all other fronts:
The citizen in us has a more difficult time being heard now in Washington and other world capitals not because big business has become more powerfully monolithic but for the opposite reason -- because competition among businesses has grown more cutthroat. Companies have entered politics to gain or keep a competitive advantage over their business rivals. The result has been a clamor of competing business interests -- a cacophony so loud as to almost drown out any serious deliberation over the public good (pp 142-143).
Right-wing ideology, favoring ever more deregulation and tax cuts, is more a result of this competition than a cause of it. Lobbying produces the ideology to accommodate business interests.

What Reich might want to rethink is his assumption that what's been bad for our politics has been good for business. In Reich's telling, the business interests that have helped to erode democracy and community have served us all supremely well in our capacities as consumers and investors. Reich's admiration extends from technological innovation to financial engineering:
Capital markets--including stock exchanges, banks and other financial institutions, and money market funds -- are far more efficient than they were decades ago, though still far from perfect.
While briefly acknowledging weak points, such as Wall Street's short-term focus and money managers' conflicts of interest, he writes: "Yet for all this, investors have triumphed, just as consumers have" (p. 95).

Uh huh. What we've now learned is that the hypercompetition Reich chronicles has been maladaptive for businesses -- starting of course with financial companies -- as well as for government, citizens and workers. As Barack Obama memorably put it last March: "What was bad for Main Street was bad for Wall Street. Pain trickled up." Among the skewed incentives: pay packages that provide individuals enormous reward for short-term gain, with no personal financial risk should gain turn to loss. A market that punishes those who eschew short-term gain that comes at the price of undue risk. A regulatory regime that weakened capital requirements, refused to regulate the market for securitizations that divorced lending risk from loan origination, and turned a blind eye to blatantly fraudulent underwriting practices. And on the international stage, global trade imbalances that flooded the U.S. government, businesses and consumers with cheap money, inducing debt-fueled consumption that proved unsustainable.

While the value of evolutionary analogies to market forces is dubious, an evolutionary tale told by Stephen Jay Gould seems at least metaphorically apt. The Irish elk flourished for a brief period from about 12,000 to 11,000 years ago before abruptly becoming extinct. During this time the male's antler set evolved to enormous proportions, eventually reaching approximately 90 lbs. According to Gould, this development was driven by competitive display -- a large set signaled dominance to other males and provided access to females. Extinction followed when the climate and habitat changed abruptly.

The analogy would be more satisfying if the 90-pound headset itself doomed the elk, but Gould doesn't assert this. What does seem relevant is that natural selection can operate in a kind of cul-de-sac in which the trait that leads individuals to success does not serve the species' overall survival capability. Evolution may be no more "efficient" than markets. Our own task, at any rate, is to shape our own environment -- to align incentives with the interests of society as a whole.

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