Reinventing the Market

Yesterday, Paul B. Farrell, columnist for Marketwatch.com wrote a rather scathing commentary about the American people – “Wall Street’s Invisible Gorilla is killing America’s soul”.

Although I do not know Paul Farrell personally so I cannot tell for sure but I think Paul was trying to communicate a dark comedic message to the American people.  Now let me be the first to admit that I like dark comedy and satire because underlying the comedic message is typically something real, something that when reflected upon makes us question ourselves, our culture and the innermost important aspects of our life.  Unfortunately after reflecting upon Paul’s message, I concluded that his commentary was not dark comedy at all but rather a rallying cry for the American populist.

Paul argues that Americans are arrogant and stupid.  To support his argument, Paul references first the Lake Wobegon Effect, a stand in title for what psychologists refer to as the superiority bias. At its core, superiority bias or the Lake Wobegon Effect states that people overestimate their positive qualities and take too lightly their negative ones.  Referring to some statistics, he makes the claim that Americans believe they are stronger, better looking and smarter than others.  Who are the others?  Although I cannot tell for sure as he does not say but it seems as though Paul is comparing Americans with citizens of other countries.

Second, Paul argues that American’s are blind to the really big, important things in society, yet myopically focused on the items seemingly important to them.  Using the Invisible Gorilla test as reference, he makes the claim that American’s have selective attention.  (For anyone who has not tried the Invisible Gorilla test you should – it is rather fascinating experiment in understanding the way our brains work. www.invisiblegorilla.com)

Paul references eight observations to support his claim that Americans have a superiority bias.  Paul states,

“All Wall Street bankers are worth 100 times any Main Street investor; All Corporate American CEOs deserve to make 400 times their workers; All children of all Forbes 400 billionaires deserve to inherit tax-free; All lobbyists deserve millions when winning billions for special interests, All taxpayers should pay for catastrophic mistakes of Wall Street Fat Cats, All rich hedge fund managers deserve to be taxed at capital gains rates, All senators deserve to become millionaire lobbyists when they retire, And Goldman Sachs CEO Lloyd Blankfein deserves a $100 million bonus”.

Regarding his second claim, Paul argues that American’s are not seeing the large Gorilla in the room – which he seems to be implying, is greed and incompetence.  Without a doubt, part of Paul’s message is concerning the “all too-greedy-to-fail-fatheads” (aka Bankers) as he calls them but it also appears as though he is making a broader judgment about business and society. He makes references to the incompetence of Alan Greenspan, Henry Paulson and even the ideology of Reaganomics in general.  While not stating it directly, Paul is condemning the idea of free-market economics.

Using the mortgage meltdown as his crutch, he is making the claim that Americans are stupid to allow income disparity between executives and non-executives, bank bailouts, incompetence in the government and to allow for risk taking at banks.

I will address a few of Paul’s comments. First, American’s are not stupid. Sure, American citizens like citizens of other countries have a superiority bias. This is empirical.  Interestingly, in the commentary Paul makes note that Canadians have a greater bias than Americans.  What about the Germans or the French?  Can you imagine the French’s perception of their strengths and weaknesses?

I must also add that sometimes superiority bias is a good thing.  Do you think that Sergey Brin, CEO of Google or Steve Jobs, CEO of Apple think that they are average?  What about Bill Gates, Larry Ellison, Mark Zuckerberg and many of the other risk takers who are making America great?  What about Henry Ford and John D. Rockefeller, do you think they sat home and doubted their abilities?  Hogwash!  Perhaps not vocal about it but I would bet that they are egotistical maniacs who think that their next widget is the best thing since eyeglasses.   Oh, by the way, the American, Ben Franklin is credited with the discovery of eyeglasses.

Rather than refer to Americans as stupid, I think perhaps a better term is “risk taker”.

I think Paul’s comment that Americans are missing the Gorilla in the room deserves some merit.  According to Paul, over the past three years Americans have been fleeced by business people, by bankers and by politicians.  I agree that Americans has been fleeced and that business people, bankers and politicians have aided in this fleecing but I think the problem goes much deeper than this.  The Gorilla in the room seems to be the ineffective, egalitarian policies that were put in place during the Great Depression.  Here are two examples among many:

Both GM and Chrysler were bailed out by taxpayers.  Who benefited in that bailout?  Was it the bankers, was it the politicians?  Probably a bit both but the main beneficiaries were the line worker and the UAW union.  Unions may have started out with the right intentions, to protect the working class but over the last 75+ years they have become nothing but a quasi-government authority overseeing the tenure of the auto worker.  Most American union autoworkers are paid substantially more than American non-union workers. If auto manufacturers want to survive then only one of three things can happen.  These manufacturers can create the best and most innovative cars which will command higher prices to support the higher union salary or they can become extremely efficient in building such cars and gaining economies of scale.  The problem with the second option is the fact that higher salaries for union-workers do not aid in a low cost, efficient production function.  Underlying both of these options is the idea that unions support tenure like careers, allowing the less innovative and less diligent workers to remain in a job for many years, yet pushing the young, aggressive, risk taker to a non-union company. If this is true, union companies will typically have less talent and higher cost structures than their non-union competitors.  If this is the case, than both options discussed are impossible.  That leaves option three which is to be relegated to sub optimality at best and a tax payer supported bankrupt company at worst..  So, what value did unions bring to the United States since the Great Depression?  The answer – NONE

Fannie Mae was bailed out.  Although with good intentions, Fannie Mae was created during the Great Depression to provide liquidity so that banks would make loans that they otherwise would not make. The intent was to ensure that mortgages were being granted to lower income, racially diverse neighborhoods.  In a dark comedic sense, Fannie Mae executed to well on its charter creating over time an entity that provided liquidity to almost all mortgage originating banks in the United States, servicing all types of people and geographies. What did this do?  Well, for starters it created a moral problem.  When banks realized they could sell their originating mortgages to Fannie Mae and get a sales fee, yet at the same time almost never run out of money and incur little to no risk they jumped into the mortgage market.  Similarly, Fannie Mae sold these loans to institutional investors.  A nice invention was created.  The problem with this invention is that risk was removed from the relationship between Fannie Mae and the originators and the risk was transferred, unbeknown to most, to the taxpayer. Ohh, by the way, the liquidity that Fannie Mae provided to the mortgage market has been creating fictitious demand in the marketplace for homes, which created the bubble that burst and left a substantial portion of the United States with homes that are now under-water.  What value did Fannie Mae bring to the United States since the Great Depression?  The answer – NONE.

What is interesting about the examples above are that they started from the populist ideologies of the 1930’s. In mid-1930, like today, the Gorilla in the room (Paul’s Gorilla) were the big, bad businesses and their immoralist bankers.  Silly as though this may sound, the bankers and businesses had almost little to do with the Crash of 1929 and the ensuing Depression.  Although the causes of the Great Depression are debatable amongst economists and politicians, most would argue that it was caused by irrationality and stupidity, the same things which Paul claims are killing America today.  Unfortunately in the 1930’s, the stupidity was not risk taking but rather risk avoidance.  The Great Depression arguably was triggered by the run on the banks and irrational panic of the investors.

The recent crisis, although it has a bank component to it, was not created by bankers, but rather was a slow amalgamation of stupid organizations and policies that were invented by the populist ideological machines that came out of the Great Depression.  If it was not for Fannie Mae, the entire idea of Securitization would probably not be around and perhaps the current crisis would not be here. Second, without unions, perhaps our American auto industry would still be innovative and competitive.  I think if there is a Gorilla in the room that we are not seeing, perhaps that Gorilla is the populist rhetoric, government institutions that create moral hazards, unions that are not needed and dare I say people of the socialist ilk.

If we want to be successful in the United States, we need to embrace free-markets and all of the painful things that go along with it.  This includes letting institutions fail when they deserve to, paying people for success, and encouraging entrepreneurship and the idea of the risk taker, despite that the fact that he or she may be an arrogant, smug American! 

As Americans, let’s get back to prudent risk taking, where we benefit when we are successful and we fail when we are miserable.  Let’s remove government programs and institutions that create risk/reward misalignments and moral hazards.  If the Great Depression taught us one thing it is that government programs and interventionist policies only hurt us in the long run.

Tags: bankers, free-markets, great depression, Marketwatch, mortgage, populist, risk-taking, socialism