Avoiding the End of The World

If possible.

David Brooks hopes to find comfort in Barack Obama’s premise that “we cannot successfully address any of our problems without addressing all of them,” but can’t. The reason is that Brooks long ago learned to distrust people who thought they had all the answers. “The political history of the 20th century is the history of social-engineering projects executed by well-intentioned people that began well and ended badly.” And Obama sounds like he’s got a big project for us all.

These experiences drove me toward the crooked timber school of public philosophy: Michael Oakeshott, Isaiah Berlin, Edward Banfield, Reinhold Niebuhr, Friedrich Hayek, Clinton Rossiter and George Orwell. These writers — some left, some right — had a sense of epistemological modesty. They knew how little we can know. They understood that we are strangers to ourselves and society is an immeasurably complex organism. They tended to be skeptical of technocratic, rationalist planning and suspicious of schemes to reorganize society from the top down.

Brooks’ view is not inconsistent with the idea that the world economic and political system is facing a comprehensive crisis. It is a not a denial of the necessity of overhauling the way we do business. It is not an argument for piecemeal responses, nor for the exclusion of a government role in managing affairs. However, it is a skeptical view of the possibility that poorly understood complex systems can be successfully managed by rigid timetables and points of view. Brooks continues:

I worry that we’re operating far beyond our economic knowledge. Every time the administration releases an initiative, I read 20 different economists with 20 different opinions. I worry that we lack the political structures to regain fiscal control. Deficits are exploding, and the president clearly wants to restrain them. But there’s no evidence that Democrats and Republicans in Congress have the courage or the mutual trust required to share the blame when taxes have to rise and benefits have to be cut.

In short we don’t have any idea of what to do except to get back to the place we were before. But what if we can’t? What if the old ways have ended permanently and we’re on our way to someplace new?  Fabius Maximus has described the recent crisis as “the end of the post-WWII geopolitical regime”. He argues it must end but without quite saying what will replace it. Gregor MacDonald believes that the US must inevitably repudiate its public debt; very well, but what do we do for a encore? The long and the short of the debate on the crisis is that while an increasing number of commentators now understand that we ain’t in Kansas anymore nobody knows where exactly we are now and what we should do. We can’t stay where we are. Which way is the Yellow Brick Road?

For example David A. Rosenberg of the Bank of America/Merill Lynch research unit says that despite all the huffing and puffing of government, the financial sector is still very, very sick.

Libor-OIS spreads have stopped narrowing and indeed have recently moved back above 100 bps, which is off the worst levels of the cycle but ten times higher than what the norm was during the positive economic cycle (2001 to 2007) – in other words, after all that has been done by Uncle Sam, the money market appears to be telling us that it thinks we are still light years away from reattaining a functioning banking system. …

How greater government involvement in major banks, with the prospect of future share dilution, is bullish is truly beyond us. The incremental and reactionary nature of policymaking in dealing with the financial crisis remains very disturbing to us and much more Japan-like than Sweden-like.

And for anyone who thinks the problem has been caused by government keeping its hands off the economy, Gerald O’Driscoll from the Cato Institute writing in the WSJ has news for us. The government already has its hands all over the economy. The major reason there is no free-market solution to the current economic problem is because government is already part of everything. Driscoll writes:

There are no good options and certainly nothing resembling a free-market solution. The government has put the taxpayer on the hook in a myriad of ways. First, there is deposit insurance. Second, there have been guarantees issued to certain creditors. Third, and most notoriously, the Treasury has invested taxpayer funds in preferred shares of certain institutions. Fourth, the Fed has lent funds on many of the dodgy assets of these banks. The Fed’s balance sheet should be consolidated with the Treasury’s in any cost-benefit calculation of alternative resolution strategies.

So with government an inevitable part of the problem, let us return to David Brook’s misgivings about the ability of government to solve things.  One reason to doubt its ability has been its failure understand the crisis in the past; its inability to manage its early manifestations. Why, besides a new face in the White House, should we believe a batter with a .000 average can can now hit at .300?  Driscoll believes government could improve dramatically if it could get politics out of the equation.

The example of the Swedish banking crisis of the early 1990s is most often cited by nationalization advocates. … In short, the resolution was handled professionally rather than politically.

The contrast with the current U.S. crisis could not be sharper. From the beginning, the handling of the U.S. crisis has been politicized. The partisanship is as toxic as the bad assets on bank balance sheets. Both parties are coming up with schemes to impede the process of foreclosing on homeowners who can’t afford their homes, which would get those homes into the hands of new owners who can afford them. Does anyone believe that a government bad bank will squeeze homeowners? To ask the question is to answer it.

Moreover, we know how the government runs financial institutions — consider Fannie Mae and Freddie Mac. Or IndyMac, whose management by the FDIC has been criticized for inflating the rescue costs through its liberal loan-modification program. A money-center bank in government hands would become a conduit for politicized lending and grants disguised as loans. That’s what’s happened at Fannie and Freddie. The government would never let go of its political ATM. You might as well consolidate such an institution with the Fed from the outset.

But even if the Obama administration could suddenly adopt the politics of Sweden rather than Chicago other problems would remain. One is the rigid nature of government itself. One of the reasons government has a hard time managing complex systems is that politics treats events largely like linear systems. Politics interprets events in the context of its mythology.  But if politics is in the best of times the art of lying to ourselves in the broad day, politics in crisis is the vice of lying to ourselves while we are falling off a cliff. And when fables meet a changing environment disaster is often the result. The second difficulty is that government is a ponderous, elephantine beast. Bureaucracies are nearly always behind the curve. Part of the requirement is to get ahead of the problem and cut out those parts of governance which contributed to the problem. But what to do when government is already part of the equation; when only government has the legitimacy to do some of things which need doing? It’s like hoping a patient who shot himself can successfully self operate to remove the bullet. Nevertheless, government can maximize its chances of helping or at least minimize its penchant for hurting by observing a few simple rules.

Two ideas are necessary to keep in mind when dealing with complex systems. The first is that it will tend to evolve towards a new state whose characteristics we may not be able to predict but which we know exists. This is what Fabius Maximus refers to as the successor the post World War 2 political/economic system.  We are going there and are going to find it by trial and error. We know enough to realize we’ve left Kansas but not enough to set our new course with exactitude. We’re going to have to sniff our way along. Once we get near there, things will start to settle down because that’s the way complex systems often behave. “An attractor is a set to which a dynamical system evolves after a long enough time. That is, points that get close enough to the attractor remain close even if slightly disturbed.” The important thing is not to charge blindly past it and over the Edge of the World.

The role of the government isn’t to mandate the characteristics of that attractor by fiat — it can’t — but rather to take the necessary steps to midwife a new world being born by taking common sense steps without the burden of ideological finality. They have to do what works unimpeded by mental constructs which cannot comprehend what is happening to the complex system. In order to successfully do this, government must embrace the second idea inherent in dealing with complex systems. It must shorten its OODA loop. It cannot be in the business of setting Five Year plans in the middle of a dynamically changing situation. Rosenberg points out that much of the so-called fiscal stimulus package is “back-loaded to the out years; that we think it will be next to impossible to meet the employment goals (which could never be verified in any event – how can anyone prove that a job was “saved’?) since much of the spending is aimed at products that are imported into the USA.” But if government wants to treat the situation as one undifferentiated bolus and shit it out in one go we may create more problems than we solve.

What government needs to implement is a succession of quick but well thought out interventions with the least possible lag, so that some kind of closed loop policy fire control system can be implemented instead of the insane method of World War 1 style battleship prediction plotting extending over a period of years. Whether policy will evolve in that direction remains to be seen. The public debate so far has been about the Big Solution; the magic bullet because leaders like to pretend that they have one. What leader can admit that he hasn’t? The day Barack Obama gets in front of national TV and says he doesn’t have the answers is the day we start getting them. Already people are losing confidence. David Rosenberg observes that a tax revolt, or at least something that threatens to be one, is now a possibility.

Well, we are starting to see the impact of policies that breed “class warfare”. And it is not about banks versus nonbanks or about the rich versus the poor, or service-providers versus manufacturers for that matter. It’s really about the government pitting prudent citizens against profligate citizens, in our view. And the IBD article is important because it seems as though we could be on the precipice of a tax revolt.

A tax revolt is good to the the extent that it militates against the ponderous central planning approach to managing the crisis. But to the degree that it encourages another, albeit alternate version of the big fix it may lead to equally bad consequences. The alternative to a bad Five Year Plan is not another Five Year Plan. It is something else. In reality the system will have to find its own new equilibrium. Capitalism is the economy’s reconnaissance in force into the uncharted economic future. The reason capitalism works is that it can try different things. Unlike government, it is not obliged to do one Awesome Thing. As we venture into the unknown some businesses won’t come back. Others will, with news of a new and boundless vistas. But we have to let them go out. We can’t strike out in a central direction determined by bones cast upon a shaman’s cape. It could lead us to the promised land, or out into the desert.

In conclusion: all interventions should be immediate, nonideological and subject to change given the arrival of new data and the speed at which we close our OODA loop should be improved. This is the way our mammalian ancestors overcame the dinosaurs. If we remember nothing else, we should remember that.

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