Wednesday, March 31, 2010

Lovelock speaks. But I wish he wouldn't

A singularly unhelpful intervention from James Lovelock of Gaia fame (or notoriety). The Guardian reports –

‘I don't think we're yet evolved to the point where we're clever enough to handle a complex a situation as climate change,’ said Lovelock in his first in-depth interview since the theft of the UEA emails last November. ‘The inertia of humans is so huge that you can't really do anything meaningful.’

One of the main obstructions to meaningful action is ‘modern democracy’, he added. ‘Even the best democracies agree that when a major war approaches, democracy must be put on hold for the time being. I have a feeling that climate change may be an issue as severe as a war. It may be necessary to put democracy on hold for a while.’
Oh really. I don’t seem to recall Lovelock’s previous analysis of the larger-scale but little-understood and even less acknowledged structures of human activity – economic systems, global technologies, ideologies – that actually provide the basis for human ‘intelligence’ as it is conventionally understood. In that rather conspicuous absence, what exactly are Lovelock’s qualifications for having such a lovingly quoted opinion? The Gaia theory, which until the environment came back to the forefront of our collective consciousness, was treated by most scientists as a somewhat quaint, if not downright silly, model of planetary processes. And even now that planetary processes are under discussion, it’s still striking how seldom Lovelock’s theories make it into scientific discourse.

Of course, given that almost all other scientists are equally lacking in any convincing understanding of how human social and economic systems work, they are no more qualified than Lovelock to pronounce on either human ‘intelligence’ or the processes and systems that driven environmental change. But at least national newspapers aren’t asking them their opinions.

More that all that, it is about time we stopped treating people as authoritative just because they have the job ‘scientist’. It’s a job that is typically highly specialised, and having read a fair number of our most prominent scientists’ accounts of our present predicament, it does not strike me that their opinions about the situation as a whole are particularly scientific. No matter how brilliant the physicist or biologist, they are no better qualified than me to pronounce on economic systems, the power of ideologies, and especially not any but the most technical aspects of solutions to our problems.

Meanwhile, putting democracy 'on hold' is not only a very bad idea but precisely the opposite of what is needed. If there are any forces that will actively resist takintg the necessary steps to deal with our environmental problems it is the entrenched corporate forces of the economy and politicl system. Closing down democracy would only strengthen, indeed perpetuate their stranglehold over economic, political and so environmental policy.

EPT: An Environment Protection Tax

Over the weekend I meet Nick, an accountant and consultant. He has an interesting idea about dealing with the environmental externalities markets are currently unable to capture. I would call is an ‘Environment Protection Tax’ – EPT for short – that would operate like the Value-Added Tax (VAT) already familiar in many countries.

After a really interesting conversation, this how I would summarise EPT as I now see it working:

  1. We have some idea of the scale of the environmental externalities caused by our economic activity. We can at least assign an approximate percentage of what is required to address the resulting environmental problems and to update our industries so that the problem goes away.
  2. A great deal of this arises from primary extraction industries – mining, oil, gas, fishing, and so on.
  3. So, why not add an appropriate percentage to the price of primary products, to be passed on (like VAT is now) to each successive buyer in the supply chain.
  4. Also like VAT, each payment is accounted for, netted out in the EPT return, and the surplus reclaimed at each stage…
  5. …until the final consumer, who cannot reclaim the tax, and thus becomes the real payer.
  6. One additional detail: that there should also be a system of tax breaks that allows anyone in the supply chain to avoid EPT if they can demonstrate that they are dealing with the externality directly. They then can reclaim the relevant portion of their EPT and convert the surplus to additional profits, more competitive prices, or anything else they chose.

The benefits of such a system are clear:

  1. It is a very simple system that requires no incessant calculation of precise externalities.
  2. We could reuse the exist VAT system to collect and disperse it.
  3. The inclusion of tax breaks would actively drive environmental improvement at every point in the supply chain.
  4. If primary production were not the best starting point for such as system, it could be readily migrated to other areas of economic activity.

Such a system would not be without its problems:

  1. Who owns the resulting fund? At the moment it could only be collected by national governments, but experience suggests that they could not be trusted to use it for its intended purposes. Most governments are understandably allergic to hypothecating taxes to specific purposes, but surely has to be an exception. After all, if it were used to supplement general taxation, it would soon stop being used for its intended purpose, not least because for the foreseeable future at least, environmental protection is a long-term game, and elected governments don’t generally do long term thinking. International institutions such as the IMF, the WTO and the United Nations are equally suspect.
  2. It’s potentially a bit crude and insensitive to the details of how externalities are really incurred and slightly out of touch with current environmental research. But at the moment this would be a small price compared with the ease and simplicity with which such a system can be understood, implemented and adapted as the level of externalities changes.
  3. The indirectness of the relationship between tax and specific externalities may leave it open to subversion. As Nick himself warned me, a whole school of accountants will spring up to take advantage of any loopholes, and they become a profession that insists on being fed and expanded even though they add nothing of social value. As to what the investment bankers could make of such a system, I shudder to think.

Tuesday, March 30, 2010

Repo 105 - Symptoms or disease?

As I asked in the previous entry about the swelling scandal surrounding Lehman's use of the so-called repo 105 accounting dodge, 'Coming to a bank near you soon? Already arrived but no one has told you? Never forget Enron and Arthur Andersen.'

So yesterday the Securities and Exchange Commission, who regulate US markets, initiated their investigation into this scandal by asking 'more than 20 financial groups' whether they used repos for the same purpose. I shall be a bit surprised if they don't use repos in general, given that repos are a perfectly respectable hedging device, but it will be interesting to see how they are used.

The SEC are not planning to get to the real bottom, though. According to the FT, their investigation will only ask 'whether companies booked repos as asset sales for accounting purposes over the past three years, and whether these deals were concentrated with certain counterparties or certain countries'.

The latter part suggests that they are looking for whether other companies or governments were parties to this dubious process, which is essential to understanding how widespread it is. But the former - the limit to three years - suggests a residual timidity about looking at real roots of the crisis - the consistent misleading of the markets and regulators over much longer periods, to build up extremely profitable but highly risky positions that cumulatively led to our collective fall. We know that Lehman's use of repo 105 went back far longer than three years; it is preposterous to believe that this only because a useful accounting tool for staving off crisis immediately before the crisis itself.

Understanding the scale and exact nature of the crisis means looking at much more than the shifting tectonic plates; it is also important to know why - and when - the decision was made to undermine the building' foundations, which made the quake so disastrous.

It will be equally interesting to see how this investigation is report by the SEC. What if it turns out that a significant number of these financial groups not only used this misleading technique in the past but are using it now? Will we hear? And exactly what will we hear. After all, what would be the repercussions of discovering that, yet again, the books are being massively cooked?

I look forward to future reports.

Monday, March 15, 2010

Repo 105 - another Enron in the pipeline?

In the arcane terminology of the markets, a 'repo' is a transaction in which I sell you something today but guarantee to buy it back for a stated price at some stated time in future. ‘Repo’ is actually short for ‘repurchase’.

Dull, huh? Well, it may turn out to be a little more exciting than it seems. If you are near the end of the quarter and you’ve got a lot of liabilities and a lot of worthless assets and your accounts are going to look lousy, why not do a deal to repo the rubbish for billions, report these as sales (which they aren't) use the billions to pay off liabilities, and then once you have reported how healthy your books now are, borrow more money you can’t afford to buy back the rubbish you 'sold' a few days previously.

This is what Lehman's called a Repo 105. It makes your books look good, it fools the regulators and everyone is briefly happy, until the time comes when the size and riskiness of the deals is so huge no one will touch them and you fall with a resounding splash down the toilet.

This, it seems is exactly what Lehman’s did - round and round for years on end, until $700 billion of assets and liabilities was being held up by just $25 billion in capital - a ration of 28:1. Their boss, Richard Fuld, claims that he had no idea this was going on. So he is either lying or spectacularly incompetent, because a) this was the only thing keeping Lehman afloat, and b) the scale of the repos – $50 billion in the first and second quarters of 2008, for example – was so huge that even if it weren’t you’d need to be dead from the neck up not to have noticed them. And the banking regulators? This had been going on for years, and no one noticed or thought that it odd?

More importantly, there is now a growing suspicion that repos are a bit more pervasive than was previously realised – if Lehmann had been doing it for years and their accountants (Ernst & Youung) didn't care - they say they were 'comfortable with the policy for purposes of auditing financial statements' - it would make sense for any of the banks and the increasingly many other businesses and government institutions who rely on financial services to generate money have been doing the same. Coming to a bank near you soon? Already arrived but no one has told you? Never forget Enron and Arthur Andersen. As Tracy Alloway, the FT Alphaville blogger puts it, 'Think window-dressing on a massive, and possibly misleading, scale'.

The story is summarised here and its full grubbiess set out here. Well worth reading.

Friday, March 12, 2010

Human intelligence and the Birth of Reason

One of my many unpublished manuscripts is a book-length treatment of the origins, evolution and individual development of intelligence, entitled The Birth of Reason. It treats the concept of 'intelligence' in the same way a biologist might treat 'life' – i.e., as a general term for everything human beings and other natural intelligences are and do, rather than (by analogy with for example, ‘the organism’) a narrowly cognitive process. That is, it is designed to explain the full span of intelligent activity, including not only the usual cognitive powers associated with that term but also the possibility of history, consciousness, global social and economic systems and so on. It includes a comprehensive account of the relationship between human and other natural forms of intelligence, such as primates. I have never tried to have this book published. I don’t really know why not – it is complete, the few people who have read it have spoken very well of it, and there are no other treatments of intelligence in this extremely broad sense of which I am aware. If you would like to know more about it, I have created a new website from which the full text can be accessed.

Tuesday, March 02, 2010

Herbert Marcuse speaks from the grave!

Having recently quoted Huxley's Brave New World on consumerism, here's an equally compelling statement of the situation, from the German philosopher Herbert Marcuse:

Tolerance toward that which is radically evil now appears as good because it serves the cohesion of the whole on the road to affluence or more affluence. The toleration of the systematic moronization of children and adults alike by publicity and propaganda, the release of destructiveness in aggressive driving, the recruitment for and training of special forces, the impotent and benevolent tolerance toward outright deception in merchandizing, waste, and planned obsolescence are not distortions and aberrations, they are the essence of a system which fosters tolerance as a means for perpetuating the struggle for existence and suppressing the alternatives.
From Marcuse's Repressive Tolerance.

Well, for people of my generation it's an interesting quote. Marcuse was one of the intellectual stars of the Left during the Sixties, so for old times' sake...

Monday, March 01, 2010

Was it caused by fractional reserve banking? Not really.

Almost a year ago, I wrote an entry in my parallel environmental blog entitled Why capitalism must expand - whatever the environmental consequences. Rather surprisingly, yesterday I received a comment, from Jerry Fox, an American engineer and blogger. His comment ran as follows:

Capitalism supported by fractional reserve banking and the artificial support of governmental bailouts does require constant expansion both to pay off the inherent interest and to delay the inflationary effects of the money supply. I hope that you are not trying to lump the great system of free enterprise which has helped to make America the envy of the world, being linked to a Constitutionally maintained money supply, to this travesty that has come to be called "Capitalism". Under the former, there is no need for constant expansion to support a healthy thriving economy along with proper concern for any environmental issues.
I repeat Jerry’s comment here because it is equally relevant to a point I have recently been considering. There is a striking difference between the diagnoses and remedies offered by American and non-American bloggers and other commentators, which, quite by chance, Jerry’s comments expresses very well.

Here is my reply, which is equally relevant to this blog:
Thanks for your comment, Jerry. I sympathise strongly with the view that fractional reserve banking has played a terrible role in the current crisis, and my impression from tracking a number of American blogs is that this is widely held to blame for the crisis as a whole. However, I remain sceptical of the idea that this is a distinct phenomenon from capitalism proper, for two reasons.

Firstly, fractional reserve banking has been a feature of financial capitalism ever since the first capitalist banks came into existence – far earlier than the fist Europeans arrived in the Americas, let alone anything specific to the US economy or constitution. It is simply a matter of risk management: although I don’t have enough reserves to cover all my commitments, I take a chance that all the chickens won’t come home to roost at the same time. And by and large this has proved a good and familiar bet – to the point where one of Shakespeare’s best known tragedies, The Merchant of Venice, which was first performed around 1596-1597, depends entirely on a situation in which this bet on fractional reserves fails.

And it was essentially the recurring failure of this bet that led to regulations specifying exactly how much reserves were required for various kinds of transaction. In other words, there was no pure capitalist system with non-fractional reserves, which was then polluted by the creation of fractional reserve banking. Rather, capitalism was always a system of fractional reserve banking, which governments, sick the regular crises, eventually normalised with formal requirements for banking licenses, specified capital requirements, the 1933 Glass-Steagal Act, and so on.

As I understand it, the issue with the recent collapses was two-fold. When markets have been massively aligned (as they were, for many reasons, over the last few years), a boom that had looked fantastic turned into a bust proved that it was all just a fantasy, because everything went up and down at once. But even more importantly, the problem with many speculations (it’s hard to describe credit default swaps as investments) was that they were not required to be backed by any reserves at all. I have seen of what would have been a large enough reserve to cover most defaults and so forestall this crisis, and none of them were very different from the standard fractional reserve requirements for more conventional loans and obligations.

You can blame a number of technical features for this – the rise of ‘mark to market’ accounting, for example. In my own view, a more profound explanation lies in the process of systematic deregulation. This seems to have been a pretty universal phenomenon – certainly rife in London, where the absence of effective capital requirements made it the most popular financial centre in the world. Other centres tended to be more reserved (as it were) than London and the various US exchanges, but unfortunately they are collectively large enough to push the planet into a financial nosedive.

So fractional reserve banking played a role in the current crisis, but primarily because it did not extend to the specific types of transaction that actually brought the system down. Not much to do with the corruption of free enterprise or Constitutionally-protected monetary system.

Warren Buffett on financial CEOs

From Buffett's characteristically frank Chairman's letter in the 2009 Berskshire Hathaway annual report (p.18):

In my view a board of directors of a huge financial institution is derelict if it does not insist that its CEO bear full responsibility for risk control. If he’s incapable of handling that job, he should look for other employment. And if he fails at it – with the government thereupon required to step in with funds or guarantees – the financial consequences for him and his board should be severe.

It has not been shareholders who have botched the operations of some of our country’s largest financial institutions. Yet they have borne the burden, with 90% or more of the value of their holdings wiped out in most cases of failure. Collectively, they have lost more than $500 billion in just the four largest financial fiascoes of the last two years. To say these owners have been “bailed-out” is to make a mockery of the term.

The CEOs and directors of the failed companies, however, have largely gone unscathed. Their fortunes may have been diminished by the disasters they oversaw, but they still live in grand style. It is the behavior of these CEOs and directors that needs to be changed: If their institutions and the country are harmed by their recklessness, they should pay a heavy price – one not reimbursable by the companies they’ve damaged nor by insurance. CEOs and, in many cases, directors have long benefitted from oversized financial carrots; some meaningful sticks now need to be part of their employment picture as well.
Pity he was so effusive about what a great manager Lloyd Blankfein is last week.

But of course the powers that be will do very little about this. They are too implicated in this mess, they have too little understanding of what has happened over the last couple of years (other than in the technical sense), and they know that if they just wait it will start to look better.

More generally, we are all implicated in this mess. As I have observed elsewhere, the financial villains and incompetents were not the real cause of the collapse. far from being the enemies of our current economic system, they and their bubble-generating, monopoly-creating strategies, methods and objectives are its apotheosis. This kind of crisis is a perfectly natural conclusion of its routine self-development over a decade or so. And that, of course, places the real solutions even further beyond our present politicians' grasp: not only do they not understand how profound the problems really are, but they are neither willing nor able to exercise the kind of political control that needed to fix the problem for good.