RIP Chicago? A Reply To Ritholtz – How To Protect Against Future Crises

You know, we argue about good and bad intentions all the time, from the left and from the right. We argue about technical or historical methods all the time. Everyone presses his little agenda.

The “corporeal error” in that ‘there are processes that have knowledge and wisdom” is something I need to write about more.

The only thing that ‘thinks’ is man.

Not gods or religions. Not processes like democracy or markets. Not numbers or formulae or models. Just individual humans. Just man.

In this posting, which is too long,

  • I argue that banking and law are both extensions of the state and effectively social services paid for on an as-used basis. And that we need to treat banking like we treat law if we are going to have fiat money, just like we need to treat law because we have legal monopoly. (Territorial monopoly on violence.).
  • I argue that property is inseparable from knowledge. (This is something I am harping on all the time, I know. But it’s central to maintaining economic calculation. In effect, it’s fraud if you represent that you own property that you don’t personally know how to use/allocate/calculate.)
  • I argue that institutions are what government should and can protect. Government cannot calculate, but it can regulate. It can regulate institutions, but not human activity.
  • I argue (suggestively) that government has to regulate both itself and the market, and that’s the problem, and we need kings.
  • I argue that we should invest in banking, infrastructure, and technological innovation, as well as establish a counter-bank for liquidating the government’s over-use of capital.

RIP Chicago School of Economics: 1976-2008

Barry Ritholtz | Dec 24, 2008
Some time ago, I asked if “Milton Friedman was the next economist whose once lauded reputation may soon slide ?”
Turns out it happened much quicker than expected. A long Bloomberg piece, Friedman Would Be Roiled as Chicago Disciples Rue Repudiation, discusses the tarnishment of the Chicago school of thought.

Its long overdue. From the efficient-market theories, to the concept of man as rational profit maximizers, much of the edifice that is was the Chicago school of economics is based on a foundation that is false, disproven or otherwise questionable.

I first encountered the Chicago theory in law school. The Chicagoists somehow read into law a market efficiency component that was never there. I recoiled against it — not because of the libertarianism, which I embraced. Rather, it seemed a backdoor way to circumvent democracy, and force into the legal system rules that were never debated, voted on, or agreed to by a representative government. I found the extremist legal theories of Judges like Richard Posner and Frank Easterbrook intellectually repulsive. They were undemocratic, anti-representative government. When I told a professor that the law and economics movement was an attempt at a political coup, he laughed and said, try to stop it.

I disliked the neoclassical price theory. It was authoritarian, a worship of a form of mob rule outside of the usual legal channels. The view that regulation and other government intervention is always inefficient compared to a free market has now been made laughable. Its always the extremists that seem to control a discipline or school of thought. If I have any dogma, its extremism in all forms is undesirable (I know, radical, huh)

If there is one silver lining in the entire collapse, its that this group of intellectual charlatans have been revealed as utterly wanting. Oh, there will be some pushback by the Chicagoans. (Watch the comments for the cute little protests from law students who never practiced a day in their lives, and the biz school kiddies who never executed a single trade).

Your fascination with democratic principles and their apparent merits, or that of the law for that matter, are even more ridiculous than the Chicago School’s fascination with markets. Perhaps, if you were paying attention, you would have seen the intellectual death of democracy over the past decade, which was the growing academic consensus prior to the financial crisis gaining the public’s attention. This movement continues to gain momentum. It is only overshadowed now by the debate over monetarism.

Reliance on democratic processes, on the law, simply puts power in the hands of those with political power. Reliance on markets simply puts power in the hands of those with money. In a redistributive fiat money system, that puts power in the hands of bankers. If we look at history, markets do better with power than do governments as long as fiat money is not involved.

Corporations and states are political entities. Markets and partnerships are financial entities. Law is a political entity. Brokerages, banks, and insurers are market entities. What we have to understand are the limits of each, so that people can respond to patterns, while choices are made by the market.

What you’re making is the “Corporeal Error”: processes cannot reason. Humans can. Human have limits to their computational ability but nearly unlimited pattern recognition abilities. The market computes that which is beyond human calculation, but it does not see patterns in itself. Governments, that is, humans can see patterns and react to them, but they cannot calculate anything of the enormity of the market. That means that, in all but the most slow-moving and rare circumstances, humans cannot regulate the market, either. They cannot have the knowledge necessary to do so. They cannot make those kind of calculations.

Cheap fiat money is the problem, pure and simple. If you use it, you have to regulate it. If you regulate it, it will become politicized. If it becomes politicized, you will have too much money in the system for economic calculation to occur.

The political answer is not so much regulation of actions and punishment, but regulation of ownership and liability. If you demand that a person have knowledge of his assets (in other words, a lender cannot escape liability, right down to the lending agent), you will preserve the ability to make economic calculation without creating obstructionist legislation, professionalize the institution, and provide incentives, punishments, and a method of insuring against malfeasance. There is no reason that lending should not be given the same serious public weight as is the law, or why bankers are not afforded the same status and liability as lawyers. But the problem is not incentive, it is knowledge. The law incorporates this idea, for different reasons, but the difference between law and banking is simply past reconciliation versus future prediction.

Centralization of computing technology and banking has created a day-laborer network of bankers who have little if any knowledge of money and banking, liability, or risk, in which all decisions are made by people with no knowledge of the properties they lend against. This process of centralization has exacerbated the fiat money problem. (Fiat money has a widespread impact on misallocating human efforts). Centralizing banking has deprived branch offices of talented staff who have knowledge of what they’re lending against, and taken away the only good financial advisor that consumers have ever had.

This breaks the law of “you can’t average everything and apply it to anything.” Or “we can’t have one insurance company for everything because if you do you haven’t insured anything, because you can’t.”

Actuarial and analytical evaluation of risk is only of merit for niches. If everyone does the same calculation they have eliminated its predictive value, and that happened industry-wide. (The mathematics and logic of this are something too deep for this forum.) It’s simply impossible to place quantitative projections on risk SETS that are that complex. Only individuals can manage that risk, and only individuals can have knowledge of their properties. Technically speaking, or at least logically speaking, you cannot have property you do not know the use of. If you do, it isn’t property any longer, because the purpose of property has nothing to do with “rights,” it has entirely to do with economic calculation within a division of knowledge and labor. (We have laws because we have property, we do not have property because we have laws.) If I don’t know about it, I can’t calculate its changing use in real time.

So we do not have any means of using mathematics to incorporate that level of knowledge, any more than we can use mathematics to argue court cases.This is  for precisely the same reasons. Lawyers are agents of the state. Bankers, as we use them under fiat money, are agents of the state. Law and lending are parallel institutions epistemologically. Our error is thinking that they are not.

The only thing I ever agreed with Galbraith on in my life was that we needed to create a bank under the Freddie’s to buy back home loans and burden the government with the problem that it created. I am no one, but I was an early proponent. Galbraith started talking about it later, but he was correct. This would have, if implemented, put a process of control into place that would have prevented such a rapid collapse, and protected the consumer, who has now woken up and decided that he doesn’t want to be the engine of the economy any longer.

So government is the problem and it always will be. The political economy operates by entirely different means than does the productive economy, and people in the government are necessarily, and somewhat preferentially, ignorant of it.

So there are your answers:

1) Look at banking as we look at law, as an extension of the state, and maintain accountability. (We did it for CEO’s, why not bankers?) You must have a stake of no less than X%, you are liable, and you need insurance for your lending habits. Insurance is a better regulator than the law, and much faster in responding. I’d even go so far as to say you need to pass the equivalent of a bar examination to be a lender. This will dramatically improve banker’s salaries, decentralize banking, create a new wave of banking investment, destabilizing the old bank power structure, and better serve consumers who now will have people lend to them based on personal relationships rather than statistical analyses. This will create a new banking economy, and one we desperately need if we are going to have fiat money. This makes the individuals in banking regulate the monetary flow based on personal liability, rather than having the government regulate it based upon punishing greed. In other words, it makes people regulate themselves because they have the knowledge and incentive to do so.

2) Create an institution that buys back bad loans to address this crisis. We have done similar things before. Give the consumer a way to protect himself. This will create certainty, and it will cause a redistribution by market channels rather than by government.

If you combined these two initiatives with a drive for a new national power grid, and say, electric cars, and perhaps, infrastructure improvements, you could refocus the economy very quickly. Banking and energy are high-performance and high-value institutions. Focus the population on opportunities rather than crises. That is the regulation we need. That is what leadership has meant in all of history: the movement of a body of people who cannot move in any direction on their own. The longer you take, the more the population’s “momentum of thought” will constrict, and the harder it will be to move them.

This is the proper place for political leadership. Not managing calculation. We know socialism doesn’t work, but socialism is the politicization of the process of economic calculation, which is logically impossible and demonstrably destructive. Social services are, however, possible, and have been since the dawn of the polis. The problem is creating social services and redistribution while letting the market perform its calculation. It is when politicians decide that processes calculate, or that there is a substitution for personal knowledge of property, that they destroy what they seek to protect. (We can have all the social services and redistribution we want as long as we preserve economic calculation and do not let politicians make monetary decisions. This is one problem libertarian theory has solved; we would simply need to implement it.)

The Chicago School simply became too technical about quantification, and too religious about the human market: micro’s error is a mirror of macro’s error. Micro doesn’t see the stickiness of certain forces. Macro doesn’t see the failures it programs into humans. There is a place for government, and that is in creating and protecting the institutions that make calculation possible. It is not to regulate and calculate. Government can’t do those things. It’s role is to regulate so that others can calculate.

That’s what the market does. That’s all it ever has done. Government should only protect institutions of calculation. When politics interferes in those institutions, it attempts to calculate, and it can’t do that. Politicians cannot be allowed to fall into the error of the political economy and think that they can perform calculation better than the market. This is the political equivalent of greed, and we call it corruption: allocating property, for compensation in political power, even if we think we’re doing a “good.” Those “good acts” become a separate economy when they become commonplace. Nor should we think that the market can build and manage institutions without regulation, or that those who operate within the market can violate those institutions of cooperation: this is what we call greed.

The problem we have is that we ask the government to regulate both itself and the market participants. We need someone to regulate the government.

Unfortunately we killed off most of our kings. That was the most vain and criminal error ever perpetuated by democracy.



Leave a Reply