The Invisible Fist of Greed and Corruption

2008 will go down as the great defeat of neoclassical economics.  While Ph.D.’s, Nobel Laureates, and pundits debate the efficacy of Adam Smith, Ayn Rand, and the Chicago School of Economics as discussed by Barry Ritholtz on Tuesday, the rest of us will still be reeling from the invisible fist of greed and corruption that took down our old form of capitalism, and replaced it with something still unknown.

While the future of economics, lending, and investment and commercial banking are ripe for change, human nature will likely not be so fortunate.  What economists need to account for is that Adam Smith’s Invisible Hand is capable of making a fist.  What philosophers will be forced to debate is whether Enlightened Selfishness as outlined by Ayn Rand is in fact an intelligent guiding principal for regulation.  And what regulators will need to contend with is a good old house-cleaning.

I have no doubt that the events of 2007, 2008 and likely 2009 are going to change institutions to their core.  From Business Schools to the SEC.  Corporations who were severely levered will find it hard to borrow even after credit markets thaw.  Not so much because credit will forever remain tight, but because our thinking will.   Our grandparents accounts of the great depression, and their stories of debt leading to failure are no longer mythical tales of disconnected financial Luddites, bards from some olden time long since forgotten. Regardless of the accuracy of the portrayal of our current circumstances and the numerous comparisons to the Great Depression, truth is that the current financial maelstrom is worse than most anyone living has ever seen.

In my opinion some of the fundamental assumptions of neoclassical economics need to be rethought, or at least redefined.  Take utility maximization.  The original definition of maximizing utility, was supposed to measure some abstract, immeasurable form of happiness.  Instead, utility has often come to mean wealth as a substitute for happiness, and the concept of wealth maximizing behavior is one of the foundations for welfare economics, a fancy way of talking about the “optimal” way of allocating wealth “efficiently.”

Selfish enlightenment or enlightened self-interest is one of the factors that drives Adam Smith’s Invisible Hand theory.  Enlightened self-interest was supposed to prevent excessive greed, corruption, and/or other market imperfections by assuming that market participants would act in accordance with a mythical set of guiding principals and values that would protect the system as a whole.

One of the first laws of economics is that resources are limited.  That said, I’ve always felt a conflict with the concept of wealth maximizing behavior.  While this could be argued sideways, my net thought is that wealth maximizing behavior, as a driving force is flawed.  If everyone always wanted more, and resources would always be limited, we would at some point reach the end of an unsustainable journey.  I do believe that market participants can be led, sold, marketed to, cajoled, manipulated or forced to want more stuff they don’t need, but it is my supposition that the human condition does not in fact always want more (while there are those who do), most people at the very least don’t want less.  The concept of wanting more may have been appropriate in an agrarian or industrial economy, however in a consumption/service economy, people shift their desires from wanting more to wanting more balance, which often includes compromising wanting more stuff for taking more time which in and of itself may not be adding value to the system as a whole.

Market equilibrium is another oxymoron these days.  If markets are efficient, and if equilibrium is supposed to exist, how have commodity prices exploded and plummeted in the blink of an eye?  Did demand skyrocket and suddenly run out of fuel and then turn down and crash?  Did supply suddenly shrink and miraculously expand at warp speed?  The answer to both of these is of course no.  And the truth is not easy to uncover, however, speculation, leverage, and derivatives I’m sure played a large part.  Market equilibrium might have existed in a time when supply and demand were unlevered.  But in the age of leverage (or gearing as it is called across the pond), demand and supply can be grossly manipulated for profit, and as we now know it can happen in the blink of an eye.  The short dollar/long oil trade was a favorite of “smart money” before the Olympics.  It was almost precisely after the Olympics that the trade unwound, fearful that China’s need to window-dress the countries wealth and efficiency would quickly dissipate.

I don’t claim to be an economist, nor all that bright.  But I do strongly believe in the expression that your business is built to run as well as it does.  Extrapolating that idea, I think our economic system has been/was built in a manner that led us to this point.  While we can, and I have placed blame across a great number of constituencies from mortgage brokers to regulators, the truth is everything that happened was bound to happen given the way we were minding the store.

Should I ever find the time, I’d love to write a long post on the Nobel Prize winners who are at least partly responsible for the frameworks that have failed in their current forms.  In the abscence of that, I look forward to seeing how new and old minds tackle the ideological undertow in the race to save capitalism.  Should capitalism fail, democracy soon shall follow.  Those are events we have not explored, black swans in all their forms, but not further from today than WWII was from 1929.