Wednesday, October 1, 2008

The Seizing of the Markets

"At a cardiac arrest, the first procedure is to take your own pulse."
--Samuel Shem, House of God

It's been a wild week plus in Washington and on Wall Street. The level of panic is the highest since 9/11, especially if you watch certain cable finance channels.

What happened? It depends on who you ask. Wall Street greed (when wasn't it about profit?). Deregulation and dangerous innovations in financial instruments. The Democrats with their low-income home loans. Or all of the above. Is the production of fear itself part of the formula? For whatever reason, here we are in a major financial panic.

It seems likely that even after the first failed vote in the House for Paulson's $700B bailout plan, with some modifications, that basic plan will be pushed through Congress. The libertarian models are not palatable to most, and public anger is subsiding as fear and resignation take its place. How much is $700B? For comparison, we have spent $648B to date on the Iraq war.

The free market ideology itself may be the biggest culprit in this disaster, because it places market efficiency over human factors, whether of realism in lending or of responsibility in handling financial instruments which at their worst threaten the entire global web of economic relationships.

The president of the Pontifical Council for Justice and Peace Cardinal Renato Martino stated: "The economic crisis, which is manifested throughout the world, perhaps is a sign that the world is not made up only of bills, money and the economy. […] [The crisis] serves as a reminder that the human person must be put at the center of the whole of world."

The U.S. Bishops also addressed a letter to Secretary Paulson and the Congress offering not technical solutions but moral principles centered on the person in approaching the economy:

  • Human and Moral Dimensions: This crisis involves far more than just economic or technical matters, but has enormous human impact and clear ethical dimensions which should be at the center of debate and decisions on how to move forward. Families are losing their homes. Retirement savings are at risk. People are losing jobs and benefits. Economic arrangements, structures and remedies should have as a fundamental purpose safeguarding human life and dignity. The scandalous search for excessive economic rewards even to the point of dangerous speculation that exacerbates the pain and losses of the more vulnerable are egregious examples of an economic ethic that places economic gain above all other values. This ignores the impact of economic decisions on the lives of real people as well as the ethical dimension of the choices we make and the moral responsibility we have for their effect on people.
  • Responsibility and Accountability: Clearly, effective measures are required which address and alter the behaviors, practices and misjudgments that led to this crisis. Sadly, greed, speculation, exploitation of vulnerable people and dishonest practices helped to bring about this serious situation. Many blameless and vulnerable people have been and will be harmed. Those who directly contributed to this crisis or profited from it should not be rewarded or escape accountability for the harm they have done. Any response of government ought to seek greater responsibility, accountability and transparency in both economic and public life.
  • Advantages and Limitations of the Market: Pope John Paul II pointed out that "the free market is the most efficient instrument for utilizing resources and effectively responding to needs. But there are many human needs which find no place on the market. It is a strict duty of justice and truth not to allow fundamental human needs to remain unsatisfied." Both public and private institutions have failed in responding to fundamental human needs. A new sense of responsibility on the part of all should include a renewal of instruments of monitoring and correction within economic institutions and the financial industry as well as effective public regulation and protection to the extent this may be clearly necessary.
  • Solidarity and the Common Good: The principle of solidarity reminds us that we are in this together and warns us that concern for narrow interests alone can make things worse. The principle of solidarity commits us to the pursuit of the common good, not the search for partisan gain or economic advantage. Protection of the vulnerable "workers, business owners, homeowners, renters, and stockholders" must be included in the commitment to protect economic institutions. As Church leaders we ask that you give proper priority to the poor and the most vulnerable.
  • Subsidiarity: Subsidiarity places a responsibility on the private actors and institutions to accept their own obligations. If they do not do so, then the larger entities, including the government, will have to step in to do what private institutions will have failed to do.


JACK said...

I have been trying to coalesce my thoughts. I have hated all the knee-jerk stuff. Some blame de-regulation when we have never had any regulations that would really have prevented this. Other's blame greed. Definitely a culprit, but I don't know if that's a full enough answer. Others blame government intervention. I actually think a really solid case can be made for this, given the government's artificial lowering of the barrier to the housing market and interest rates generally to credit. But even still, I'm not sure if that totally explains things.

I think those who are out there talking about systemic risk are getting closest to the mark. While no doubt, greed has motivated a lot of behavior, I think what has made this so devastating is all the financial ingenuity. We have built all sorts of new financial products which, in and of themselves, are not bad things. They can be used wisely or carelessly. But what they have clearly done is making the entire system far more tied together and so the wave of chaos resonates through more and more quickly.

To get a feel for what I am talking about, consider the effect of the internet on practicing law. It used to be a slow process to negotiate a contract, simply from the fact of how long it took to produce a typed copy with hand marked changes, using carbon copies, and then send them in the mail. That was sped up a bit by computers and xerox machines, but it accelerated exponentially when the documents could be sent by email. This brought with it lots of productivity and efficiency gains. But it also brought a huge cost. Expectations of speed volumed and now contracts people used to negotiate far more slowly and carefully are expected to be done overnight.

Well, something similar I think has happened in our financial markets. We have come up with all sorts of ingenious ways to securities debt payment streams and trade them and there's been some wonderful gains because of it. But it has brought along with it an unexpected downside. The more everything has become tradeable in the economy the less there is a barrier in the system that slows down the reverberation of any problems. I saw one commentary compare it to creating a system where if you stub your toe your heart reacts to that with a heart attack.

I think that's the element knowing is examining closely. And it doesn't lend itself to convenient free-market or governmental regulation answers, because most of all it requires actually analyzing the situation to see a structural problem that is very deep and hidden amongst good structure.

I also wish that more humility would be shown by all the news media and talking class. Honestly, this is a huge bet. No one knows if the bailout can actually do anything. Personally, I think this is beyond what the government can do and there are certainly far better options than the one the government chose if it was going to intervene. And there's unfortunately no way to measure if the bill is a success. (You can't say if we don't see a depression that the bailout prevented it.)

And what concerns me is that many seem so focused on the short term consequences of inaction with an overly optimistic view of what action can do, but little if any concern seems to be given to the long-term consequences of action. If the bill does nothing to solve the current problem but instead sets in motion things that leads to a worsening situation that just won't reveal itself in 10 years or so, we all will be for the worse. I'm not confident any of my representatives spent more than 10 seconds in serious thought about that.

Here's hoping we don't become Japan!

clairity said...

Jack -- I'm glad we smoked you out! Your insights are so interesting, that I'd love to see you post them separately so they don't get lost in the combox, both of your comments.