THE (HERETOFORE OVERLOOKED?) INNOVATION IN BANKING IN THE PAST 30 YEARS AND ITS EFFECT ON OUR PRESENT ECONOMY

This piece is about something that I think people have sort of talked about, and around, but not really homed-in on adequately and placed in the proper economic historic framework. It is about another significant “innovation” that occurred over the past 30 years that has run the course of boom to bust and how people didn’t see this innovation in the proper historic boom to bust frame. As you know, I have previously framed much of the deterioration in the economy to the huge historic economic arch of a paradigm shifting innovation, that leads to a ramping-up in overall economic growth, which then ends in a mature “product” that has little room for enough growth to keep the economy growing. (See Below ***) Additionally because the creation of the product becomes more “efficient” this leads to higher productivity and, consequently, jobs are shed in the end-term process. The end result is either a severe recession or a depression. We have seen this time and time again beginning with manifest destiny (our country’s growth west) and also includes electricity, the transistor, the post-war baby boom and computers. The one that seems to have been left out of the discussion to date, at least in the context of the historic arch in which I have expressed interest, is the one I wish to write about: a paradigm shifting innovation in banking.

Through most of the twentieth century banking was local and, therefore, relatively small on a company-to-company level. State and federal regulations created this structure. However, starting in the late 70's, these regulations were lifted. As a result, banks became larger, crossed state lines, and, arguably, more efficient (See: The Real Effects of U.S. Banking Deregulation, http://research.stlouisfed.org/publications/review/03/07/Strahan.pdf). The author of this article, publishing in 2003, lays out the history of this deregulation and how it has seemingly lead to a significant amount of overall growth in the economy. He saw this is being “all good” but he didn’t see the dark side and he didn’t see the historic boom to bust frame I have referred to previously. In fact, all he saw was good times ahead. Of course, he was wrong.

One of the reasons he was wrong was he failed to consider the general historic boom to bust frame, more on this shortly. But another reason he, and others, were wrong, was that he/they didn’t see the inherent problems of taking small, largely privately held, banks away and leaving large, stockholder-owned, banks in their place. I believe this to be a significant mistake. As Paul Krugman summarized in a 2009 article in the NY Time Magazine:

By 1970 or so, however, the study of financial markets seemed to have been taken over by Voltaire’s Dr. Pangloss, who insisted that we live in the best of all possible worlds. Discussion of investor irrationality, of bubbles, of destructive speculation had virtually disappeared from academic discourse. The field was dominated by the “efficient-market hypothesis,” promulgated by Eugene Fama of the University of Chicago, which claims that financial markets price assets precisely at their intrinsic worth given all publicly available information. (The price of a company’s stock, for example, always accurately reflects the company’s value given the information available on the company’s earnings, its business prospects and so on.) And by the 1980s, finance economists, notably Michael Jensen of the Harvard Business School, were arguing that because financial markets always get prices right, the best thing corporate chieftains can do, not just for themselves but for the sake of the economy, is to maximize their stock prices. In other words, finance economists believed that we should put the capital development of the nation in the hands of what Keynes had called a “casino.” How Did Economists Get It So Wrong? http://www.nytimes.com/2009/09/06/magazine/06Economic-t.html?_r=1&scp=3&sq=krugman&st=cse (Emphasis added)

Now here’s the problem created by this “irrational exuberance” Krugman writes about. When there is an innovative “product”, “service”, “paradigm”, that begins its inevitable transition from maturity to petering-out, a company is caught between a rock and a hard place because growth declines as the innovative “product”, “service”, etc., matures. Declining growth means declining profits and declining profits mean declining stock prices. Yet, if one accepts the “efficient-market hypothesis” the solution for any company becomes the creation of “the appearance of growth” at any cost because, if you don’t, your company tanks in the stock market. Although it is a minor example, I see evidence of this “profit at any cost,” and the petering-out of the banking innovation, in the recent report that some financial institutions are looking into the possibility of purchasing grandpa’s and grandma’s insurance policies for needed cash (needed because of the market crash) and then packaging them into bonds as they did with the mortgages. http://www.nytimes.com/2009/09/06/business/06insurance.html?scp=8&sq=insurance&st=cse To me, this is evidence of how desperate these companies are for profit-making services and, if they have to stoop to this level, how bad the situation really is.

While it is not my area, I think that if someone looks at the development of these financial derivatives, loose mortgage and other lending practices (that were necessary to insure continued profits to satisfy the “efficient-market hypothesis” beast), you might just see they started around the same time as the banking expansion that started in the early 80's was losing some of its velocity. These large banking institutions needed these new revenue sources to prop-up their profit sheets (Rule “efficient-market hypothesis,” rule) and no one bothered to ask the question whether this was sound because the “efficient-market hypothesis” ipso facto conferred soundness on these practices.

So where does that leave us. Well, if I am right about this, and the other innovation I wrote about previously (computers), here’s what I see. First, I now see two, not one, innovations that have reached their post-economic growth creation phase: a) the banking innovation and b) the computer innovation (and remember how much a part of our economic growth these two “innovations’ have been in the past 20-30 years). Second, while I see the banking innovation running the usual course, as I wrote previously, the computer innovation will continue to cause problems because, unlike any previous innovation, the computer innovation will continue to make companies more efficient, and they will have to become more efficient in this economic climate, therefore jobs will continue to be lost. Third, as tax revenues continue to decline, particularly on the state and local levels, the one area that has seen genuine job growth over the past ten years, government jobs, will see both lay-offs and an increase in furlough days and the like. The effect on consumer spending of this is obvious. Fourth, we still have the commercial real estate and consumer debt bubbles to come. More or less, I believe this will remain the situation until: a) our economy flattens out vis a vis the rest of the world; and/or 2) we come up with that random paradigm shifting innovation to jump-start sustained, accelerated, growth sufficient to recapture the millions of jobs lost up to the point of the appearance of this new innovation.

*** 2/21/09

I am still caught in this thought pattern where I can't really see a way out even in five years, and remember the FED said this is predicated on nothing else really going wrong. In the column earlier this week, Krugman observes the CBO has projected there will be a $2.9 trillion difference over the next three years between what industry can produce and what can be consumed. When I went back to my text book on the economy, I saw that sort of discrepancy, between productivity and consumption, seems to be a factor in bringing about a depression. On the plus side, this is why we must, at any cost, create jobs. But, long term, I see this as possibly being very different because what has brought about increased productivity, computers, etc., will continue ad infinitum, meaning some sort of continued downturn in jobs. In fact, as business continues to worsen, existing businesses will be forced to become more efficient/productive and those changes will not go away upon recovery. Right now, I see this as possibly being some sort of reverse Malthus thing where there may never be enough consumers for full production, and jobs continue to decline until the next huge thing (like electricity, the combustible engine, etc.) that will result in the creation of a large number of jobs directly or indirectly. This sort of thing cannot be planned. It is like a mutation, it just happens. The other thing that worries me is during the Great Depression, it was the commercial banks, largely, that purchased the debt that drove the New Deal and then the War. As such, as my text book put it, our debt was largely contained within our borders. Not so this time around. So when the time comes to pay the debt back, instead of the debt being in our economy, it will be in some other country's economy. Thus, ultimately, we will lose this potential multiplier.

© Copyrighted by James N. Perlman. 2010 All rights reserved.

THE GREATEST LOVE SONG OF THE MODERN/ROCK ERA

A few days ago, a friend and I were discussing the greatest love songs of the modern/rock era. As we were going to see Mark Knopfler later that night, and his song “Romeo and Juliet” was on the radio at the moment this conversation was occurring, it was easy, and correct, to put that song in the top ten. Later that night, Knopfler proved the point at the Chicago Theatre.

Also on the list must be John Lennon’s “In My Life” even though it was inspired by you-know-who (Bring to the fore the importance of not getting confused between art and the object of the art.). David Bowie’s “Heroes” belongs at the top of this list too. But now that I have had the opportunity to think about it some more, and just happened to listen to this song this morning, I have come to realize the greatest love song of the modern era is Bob Dylan’s “Tangled-Up In Blue.” Allow me to explain.

The significance of Bob Dylan to the craft of song writing cannot be overstated. There is before Dylan and after Dylan. The after Dylan is that from this point on, a song, particularly a love song, could be as emotionally complex, as filled with white hot anger, as other forms of art. Dylan will start arguably his most important song with “Once upon a time” and then go on to prove there was never a once upon a time quite like this in any previous song. Previously, white hot anger had been only hinted at and some times hidden. Woody Guthrie’s “This Land Is Your Land” is actually an angry song (written as an angry response to Irving Berlin’s “God Bless America”). But Woody hid that so well, to his regret later in life, that even now people like Glenn Beck are surprised by its real meaning. But all you have to do is read the legendary, and forgotten, fifth and sixth verses, and the meaning is plain as day:

As I was walkin' - I saw a sign there
And that sign said - no tress passin'
But on the other side .... it didn't say nothin!
Now that side was made for you and me!

Chorus

In the squares of the city - In the shadow of the steeple
Near the relief office - I see my people
And some are grumblin' and some are wonderin'
If this land's still made for you and me.

http://www.arlo.net/resources/lyrics/this-land.shtml

Dylan added and built upon songs like this. One thing that Dylan did was to both obscure and yet deepen meaning, often at the same time. Interestingly, perhaps the best place to find this is in Dylan’s long poem “Last Thoughts On Woody Guthrie.” In this poem, Dylan goes on for line after line, something like nine minutes, seemingly at times not making any sense at all, and then he drops the bomb of simplicity and beauty right there at the end:

You can touch and twist
And turn two kinds of doorknobs
You can either go to the church of your choice
Or you can go to Brooklyn State Hospital
You'll find God in the church of your choice
You'll find Woody Guthrie in Brooklyn State Hospital

And though it's only my opinion
I may be right or wrong
You'll find them both
In the Grand Canyon
At sundown

http://www.bobdylan.com/#/songs/last-thoughts-woody-guthrie

And with these last few lines, you now know that every seemingly senseless line now makes perfect sense. No one in the pop idiom had ever done anything like this before. But Dylan has done it time and time again; just like he does in “Tangled Up In Blue.”

Let’s start with the title. The protagonist(s) isn’t blue, he’s tangled up in blue. As Johnny Slash would put it: “Totally different head, totally.” Delve deeper into the song and you find jumps in time and space. A lack of clarity as to whether there are one or multiple protagonists. Then there is the flood of lyrics and images, my favorite being:

And every one of them words rang true
And glowed like burnin’ coal
Pourin’ off of every page
Like it was written in my soul from me to you
Tangled up in blue

http://www.bobdylan.com/#/songs/tangled-up-in-blue

The brilliance of Dylan in this song is while each verse seems to change location, change time, he puts you right there with his images and you don’t know, you feel, exactly what he wants you to feel. And what he wants you to feel is the inevitability of the last verse, that starts out:

So now I’m goin’ back again
I got to get to her somehow

But still, by the end of the song, it isn’t clear whether he will or he won’t. It is also clear it is absolutely meaningless whether he does or doesn’t. Love’s like that. And so is Bob Dylan. No one wrote a love song quite like this before and no one succeeded better. Sounds like a Number 1 to me.


© Copyrighted by James N. Perlman. 2010 All rights reserved.

USING GAME THEORY TO ANALYZE BARACK OBAMA’S AND THE DEMOCRATIC PARTY’S FAILURES IN THE HEALTH CARE DEBATE

For another essay critical of President Obama’s leadership abilities and handling of a policy matter see: ANYWAY YOU LOOK AT IT YOU LOSE – TWO METHODS FOR EVALUATING BARACK OBAMA’S LEADERSHIP ABILITIES

Game Theory is a powerful tool to analyze and strategize a situation like the health care debate. Last week, I watched the first on-line lecture by Yale professor, Benjamin Polak, on Game Theory. http://academicearth.org/courses/game-theory It was during Prof. Polak’s presentation, in 2007, but founded on the most basic of Game Theory principles, that I began to analyze the health care debate under Game Theory.

At this point, without getting to the other lectures, which I haven’t seen but intend to, what seemed clear to me is President Obama selected the wrong opening strategy for framing the health care debate, which he is now correcting, but with the damage already done.

The five rules Prof. Polak set out in the first Game Theory lecture are:

1. Figure out what you want before you try to get what you want.
a. Payoffs Matter
2. Put yourself in other people’s shoes.
a. Understand what the other player’s desired payoffs are and what, if anything, the other player would accept as a payoff.
3. We are evil.
4. Rational choices can lead to bad outcomes.
5. Don’t play a strictly dominated strategy.

Prof. Polak also sets out two types of players: the Evil Gits and the Indignant Angels. He informs that being an Evil Git is always advantageous if the payoff is larger regardless of what strategy the other players choose. As for the Indignant Angel, this can be a losing strategy because often it is a dominated strategy. For this reason, when an Indignant Angel is playing against an Evil Git he should choose a comparable Evil Git strategy, e.g. choose a dominant strategy, in order to obtain the best possible result.

When I apply these rules to the health care debate, here’s what I see.

The Republicans have been nearly uniformly the student who is going for the A, the largest personal payoff, without thought to the other players. Further, we have known from the get-go what the Republicans want as the payoffs: a return to power. They never possessed an actual interest in a process of compromise that would result in a health care bill. Thus, in the health care debate they are the Evil Git. Obama failed to consider rules 3 and 1 above by putting himself in the Republicans’ shoes and thereby understand what the Republicans wished for as their desired payoff. Instead, Obama employed a rational course of action and, in the process, framed himself as largely an Indignant Angel. As a result of Obama’s failed analysis, under a Game Theory paradigm, he needlessly boxed himself into a largely dominated posture.

I am sure when I get to the other lectures by Prof. Polak the available options that Obama, and the Dems, possessed will become clearer. Quite possibly, there were other opening strategies that would have been more fruitful before Obama migrated to the end-game Evil Git strategy. But, at the very least, one can say that initially meeting an Evil Git strategy with an opening Indignant Angel strategy was flawed. Further, I believe Obama has waited too long to correct his mistaken opening strategy. He may still get a health care bill. But, in the process, he has incurred more damage than needed.

The potentially good news is now Obama is finally meeting the Republicans’ Evil Git strategy with an Evil Git strategy of his own. This started with the televised Health Care summit a couple of weeks ago where Obama began to reframe his strategy as less dominated Indignant Angel and more Evil Git. Obama finally understands what Nancy Pelosi has understood all along: that when the payoff is greater, in this instance the Republicans’ desired payoff to foil Obama and return to power in both Congress and the White House, this has to be met with a comparable Evil Git strategy. This is one of the reasons the right can’t stand Pelosi. Evidence of Obama’s conversion can be found in comments by, and about, Rahm Emanuel in this Sunday’s New York Times Magazine article about Rahm,
http://www.nytimes.com/2010/03/14/magazine/14emanuel-t.html?scp=2&sq=rahm&st=cse, where it was reported:

Emanuel wants to jam a wedge into the fissure inside the Republican Party between, as he frames it, the descending wing that believes in small government and the ascending wing that believes in no government. Republicans lose, in this theory, whether they cooperate with Obama or not. “We’ve got to drive the ball at them,” a senior White House official told me. “Driving the ball at them, making them pick between small government and no government, putting them in their responsibility-and-accountability box. You walk away? You’re walking away from responsibility, and the public’s angry at you. You participate? Your base hates you.”

This is precisely, I mean precisely, the frame that Obama was crafting during the health care summit. Matt Drudge gets this. So do the other conservatives. This is why their rhetoric has become so strident and shrill since the summit.

Back in the Depression, Roosevelt's brilliance was: 1) he employed a largely dominating strategy; 2) he communicated often and powerfully with the American people and 3) he was a natural father figure. How perfect for the times and the problems he faced. Obama doesn't have #3. But he certainly possesses the skill to have done a better job with #2 and he chose to play a strategy that allowed the Republicans to dominate. All this should have been obvious under the known circumstance if he, and his advisers, had initially used Game Theory more fully to analyze the problem from the beginning instead of apparently coming to it this late in the process.

© Copyrighted by James N. Perlman. 2010 All rights reserved.