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Clean Government Now

Reputation and other skills for the next generation of leaders

Click below for a treatment for a book on reputation theory, which allows leaders to use trust mechanisms as a way to make their organizations more efficient and effective.

Book Treatment .pdf Link

Posted by CleanGovernmentNow at 2/12/2011 11:32 PM | Add Comment

The Hangover

After recent euphoria, the Bay Area is in for a serious hangover. The party was great: The SF Giants won a first World Series against those Bush-infused Texas Rangers, and blue state locals let the red state tea-totalers know they had no intention of calling it a night. Unfortunately, reality is about to hit hard. As The Wall Street Journal put it: California has become the Lindsay Lohan State. Meanwhile, the NYT is reporting that bondholders are balking at the bill. In the end, the Giants' win was epic, but still vicarious entertainment. And what Tea Party goers might lack in spelling skills, they make up for in true insight: it is time to sober up.

By objective measures, California's state government has failed. California ranks at the bottom of every scale of accountability. Despite our temperate climate, we have the nation's second worst roads and bridges. We rank 36th for crime incidents and public safety. Our public education lags well behind the nation. Public development is moribund and critical public works are interminable. Environmental stewardship is stagnant. Our debt is unsustainable without federal bailout funds, which are not coming from the next Congress. Public pension obligations are dramatically underfunded, drawing billions of our tax dollars that should go to services.

The only thing we know for certain: California’s failure is not due to a lack of government resources or the energy and commitment of its people, but to the gross negligence and a failure of civic duty by its leaders. Our sales tax (10%), property taxes (14 mils), and income taxes (10%, including ordinary income rates on capital gains) rank as the second most onerous in the nation. Fees, fines, fares, and tolls are ubiquitous and historically high. It is official: Californians pay the most and get the least for their money. Just how is it we suffer some of the worst government management since the days of Caligula?

A large part of the problem is the inmates run the asylum. Incredibly, public unions use our tax dollars by the millions in campaigns to defame anyone who comes close to threatening what can only be described as a quasi-criminal enterprise. $900,000 per year salaries for Bell city managers, $750,000 per year for Alameda county health care administrators, $8 million pensions for San Francisco assistant police chiefs. These are no longer public servants. They are public malefactors. If it bothers me that Buster Posey or Tim Lincecum made millions, I can avoid the Giants. If I didn't like Meg Whitman's salary, I could have stopped using EBay. A problem with Carly Fiorina's management? I could change jobs. But if I find the management of California's public bodies outrageous, my only choice is to uproot my entire family, career and business and go to another state. Unfortunately, both inside and outside of California that equation has become all too apparent.

As a political culture, California has always had an eclectic blend of transplanted liberalism, unbridled personal ambition, and a native Western libertarian streak – both the intellectual and cowboy sort. With physical beauty, a savory climate and energetic transplants from across the country and the world, we could get it together when needed. We put the past aside and planned the future – often the future of the world. History? Tradition? Not as interesting when you have the next, next thing. Or at least Twitter and Zynga. Unfortunately, historical amnesia has a price. In the face of adversity, amnesiacs lose perspective, regress, cling to illusions, and draw blanks. Their imagination looks not to the travails and triumphs of the past for bearing and strength, but to the fickle flirtations, impulses and “why not me” envies of this year's accidental successes (movie stars, dot com wonders, sport titans). When these infatuations fail, as they invariably do, regression sets in.

The 2010 California electoral results were just such an exercise in collective historical amnesia and failure of nerve. Californians were offered up two dedicated, accomplished women (Meg Whitman and Carly Fiorina) with desperately needed leadership and management talents. But they saw only the risk and not the reward. This was a moment when California society took one of those regrettable turns. Otherwise capable of so much innovation, creativity, and sense of challenge, Californians sought solace from the economic downturn anywhere but in the real world of cause and consequence -- the daily stuff of leaders like Meg and Carly. In fairness to the voters of California, Meg and Carly did not do nearly enough by way of prior public service (as opposed to business) accomplishment to prove that either of them was a risk worth the taking. Meg Whitman couldn't even be bothered to vote.

Still, the case against Barbara Boxer and Jerry Brown was much stronger. As placeholders for nearly six collective decades in failing organizations, they were simply instruments of collective denial. This pair has accomplished little for others in their aggregate 140 years on the planet. A pet project here or there. A huge dose of self-interest and corruption everywhere else. They represent anti-leaders – drab wallflowers that have achieved significant personal comfort despite mediocrity. They maintain their station by incessantly tearing down their betters and playing to regressive elements. Like the segregationist Democrats of the old South, change is anathema and hopelessness pervades their efforts. Will the man who gave public unions collective bargaining be the one to undo their disastrous consequences? Very doubtful.

One spring leaf of hope on the horizon came from Proposition 20, which the voters overwhelmingly approved. One might debate this particular solution on the issued of redistricting, but the fact is Californians know the patient is sick and dying. They know Sacramento is simply not a place that can be trusted with fundamental liberties. That is a sad commentary, but at least people are aware of the disease.

My fervent hope is that we can punch the accelerator of real change before it is too late.

Posted by CleanGovernmentNow at 11/17/2010 2:47 PM | View Comments (1) | Add Comment

Revisiting the Buckley Rule

The Buckley Rule has received a lot of attention recently, as one seasoned moderate after another has been toppled in Republican primaries by Tea Party purists. Inspired by the Alaskan Joan of Arc, a band of pitchfork-wielding villagers and exurbanites have given the heave ho to anyone that looks the slightest bit too comfortable in the Beltway.

The Buckley Rule posits that conservatives should vote for the most conservative person who is electable in a general election. Given the wisdom and wit of its author, William F. Buckley, the Rule deserves serious consideration and respect.

Many savvy modern conservatives are understandably concerned that Republican control of the Senate will elude the movement because of the lack of tactical prowess on the part of the Tea Partiers in ignoring the Buckley Rule. By demanding the whole enchilada, the reasoning goes, they risk getting the same stale chips (aka Pelosi, Reid, etc.) instead of a half order.

Based on his own rule, Buckley backed Richard Nixon over Barry Goldwater. This factoid alone should raise some interest among conservatives in refining the rule. Nixon was a scurrilous, unprincipled politician with few redeeming qualities. He introduced such creepy tactics as the "Southern Strategy", looked askance at voter fraud, and left a Keynesian economic ruin in the making. Oh, and that unfortunate office break in incident and subsequent fall out. Nixon possessed few qualities of leadership and hatched much of what has proven unhealthy in American politics. And, of course, Nixon's failings gave us arguably the worst president in modern history: Jimmy Carter.

In the modern media age, the volatility of the electorate is high, labels are transitory, and confidence in "the system" has rarely been lower. Therefore, it seems a good time to revisit the Buckley Rule. An asterix on "conservative" should indicate that regardless of how a candidate might label themselves, they deserve zero support unless they have read, understood, support and practice the principles embodied in the (i) Constitution, (ii) the moral/ethical texts of modern civilization, and (iii) the works of Frederick Hayek.

Remember, the person who will lie for you, will lie to you.

Posted by CleanGovernmentNow at 9/19/2010 9:03 PM | Add Comment

How to Slay a Leviathan ... and other skills for the next generation of leaders

CLICK HERE for a draft introduction to: How to Slay a Leviathan and other skills for the next generation of leaders.

The ambition of this book is to bring a fresh, limited government perspective to leadership and good government studies, which have historically been dominated by big government, central planning advocates with little experience outside academia and the bureaucracies or large companies they wish to transform.

By using reputation theory to foster and maintain working markets in commerce, finance or ideas, leaders can be more successful and deliver us from our current stagnation.

It will also be useful to business and non-profit leaders working to improve their organizations and implement fundamental change with an eye toward dynamism, efficiency, success and sustainability.

kurtisfechtmeyer aT mac DoT com

Posted by CleanGovernmentNow at 6/22/2010 10:12 AM | Add Comment

Dodd Financial Reform: Recipe Included

As with other parts of the New New Deal our leaders are peddling, the Dodd financial reform package is a perfect storm of blame game, confusion, and ignorance. As for reform? Not so much. When principled people on the left (Feingold; Cantwell) join ranks with Republicans against a bill, a Potomac sewer rat (excuse me, vole) is in the house. You have to look deep within the bill for its few redeeming features, and these are unlikely to outweigh certain negative results.

First, the bill barely touches on the mortgage industry at the heart of the financial crisis. Second, despite its populist trappings, its 1400+ pages only works to the favor of those parties rich enough to buy the legal army needed to wade through it and comply. Third, the bill does nothing to address bi-partisan concerns about the last Wall Street "reform" courtesy of Messrs. Sabanes, Oxley and Spitzer. This previous set of good intentions all but killed the small cap public equity market and the venture business that depended upon it. Could we fix that mess first? Take a ticket. How about funding innovation? So last century. Finally, a bill this important should be crafted by brilliant public-minded leaders above the political fray and steeped in real world experience. Instead of Louis Brandeis, however, we get a script written in an echo chamber by HuffPo-reading political staffers, corporate shills, and politicians interested foremost in salvaging their own complicit hides.

In a nutshell: this bill will make the Washington-Wall Street nexus tighter than ever and bailouts (by any other name) more likely.

One of the great historical accidents that favored the American capital industry and our economy generally was that our financial center, New York, and other regional centers such as San Francisco, were physically separated from the tinkering (however well intentioned) and envies of Washington. No more. This bill takes another step toward a continental regime of capital + cronies -- Athens circa 2010 by way of Chicago circa 1930. The bill also spins the nausea-inducing yarn that the financial crisis was the result of "wild speculation" and "exotic instruments" on Wall Street. In fact, the crisis was specifically about $2T of mundane (but fake) AAA mortgage securities supported by (a) shaky insurance via a politically-connected well spring (AIG), which the bill barely mentions, (b) a ratings oligopoly sanctioned by the government with no shortage of the same "experts" this bill further embraces, and (c) a government-sponsored secondary market via Fannie Mae and Freddie Mac, which this bill ignores entirely.

Why does the bill place new burdens on private equity funds, venture capital, corporate governance, municipal bonds, credit cards and other matters that are non-systemic in nature and had absolutely nothing to do with the sub-prime mortgage crisis? Any more questions before we shoot that canary making noise in the corner? The response to every wrong (perceived or real), is a flat-footed federal agency with too much authority and too little real experience. Instead of applauding the power of well-policed markets and the native interests and intelligence that drive the vast majority of American business and financial leaders, the bill puts the vain courtiers and egoists of the political court in the center of the financial stage, where they'll expect applause no matter how lame their performance. With broad drivel about "consumers" and "risk" empowering new super-agencies, the rule of law will be no match for a new breed of disastrous do-gooders in the vein of Fannie Mae and Freddie Mac.

Any more question before we begin another reading of Alice in Wonderland?

Let's roll the tape from Senator Dodd's own committee:

- Consumer Financial Protection Bureau. There is no evidence that a financial crisis driven by inflated housing values represented: "an across-the-board failure to protect consumers". This is convenient fiction at best. A harmful lie at its worst. Any "schemes" involved in the crisis were real estate scams by borrowers, builders, and flippers to speculate locally and/or defraud lenders. Inflated housing values? Thank a strong economy, low unemployment and the same low interest rates and ready credit the government continues to promote.

Certainly, some had the misfortune of hitting the top of the housing cycle and/or used low-down payment, NINJA and other ill-advised reset loans. Individuals also lied on loan applications. But who pushed these instruments, juiced the housing market, and eased loan requirements? The same consumer-focused "affordability" advocates that will likely populate the new agency.

I have suggested Luigi Zingales' debt-for-equity swaps and other real solutions to help consumers caught up in bad timing and a bad economy, but this bill's premise belies all the talk we hear now from liberals about how they support "personal responsibility". These are people buying houses, not digging in dumpsters. We should anticipate diligence from them. This bill WILL certainly mean fewer banks, as less will be able to afford to comply with a new federal blanket of rules. Competition will decrease. Consumers will suffer. The same "affordability" advocates that brought us skyrocketing college and housing costs are not the solution. They are a problem. A gratuitous layer of bureaucracy increases costs and decreases the best protection consumers have: the ability to switch providers.

Far from helping consumers, this bill will have the opposite effect.

- Financial Stability Oversight Council. 9 Mandarins, who will "identify risks" and sweep anything deemed "risky" under the Federal Reserve's purview. Bad Idea. Very bad idea.

Chaired by the Treasury Secretary, this new financial Council of Trent will have strange and surprising powers, intermingling monetary, banking and securities functions in a charged political environment. Mind you, we now have a Treasury Secretary, who gleefully admits he "has never held a real job". But not to worry, according to Dodd's release, a new "Office of Financial Research" will be staffed with "highly sophisticated economists, accountants, lawyers, supervisors , and other specialists" Hmmm. What seems to be missing? How about someone who has actually worked in the securities industry or in banking, and not just a vacuum sealed policy environment. To a Washington bureaucrat, stepping outside in a drizzle is a risk. How on earth will they get the risk/reward balance correct with nothing in play? This is classic central planning myopia that has failed again and again. And what on earth is the person who is supposed to watch the federal treasury doing watching every else's treasure as well?

- Ending too Big to Fail Bailouts. Really? Once you get beyond a few lines stolen from the Tea Party, you find a morass of contradictory provisions that do little to forestall bailout nation and completely ignores the elephant in the room.

In reality, almost all the TARP money that went to banks was paid back soon thereafter, and most banks never wanted it in the first place. Who was actually bailed out to the tune of hundreds of billions? Fannie Mae and Freddie Mac. Does this bill have anything to do with Fannie Mae and Freddie Mac? Nada. Zippo. Zilch. There are several dishonest assertions in the bill, but the most disingenuous is the notion that it addresses "too big to fail." By getting Washington all that more in bed with Wall Street, too big to fail really means: you're not connected enough to survive.

Then, the bill proposes a series of half-baked attempts to place proprietary trading, derivatives, hedge funds and private equity funds into one big "suspect" class -- as if any of these are even vaguely related in terms of their risk dynamics and appropriateness for deposit institutions. But don't worry, the Council will sort this out. How? When? Where? Accountable to Whom? The whole construct is ludicrous and smacks of desperation to pass anything and sort out the mess later. Sound familiar?

Does our regulatory regime deserve a makeover? Yes. Does it need a blue ribbon panel of experienced former industry luminaries who love their country and their industry? Maybe. What about a council of Washington mandarins and careerists? No.

- Transparency and Accountability for Derivatives. At long last, we find a provision in the bill that seems to acknowledge something exists that is called a market. Revelation. And perhaps some simple honest policing and transparency would go a long way to making it work better. Hurrah.

Putting aside the misguided analysis about the role of derivatives in the financial crisis, transparent, well-policed markets are an admirable goal of this legislation. If our legislators simply addressed that one element, this would have been a supportable quest. Not surprisingly, this is a provision with actual bi-partisan support, leaving one to wonder why the rest of the bill goes off on an ideological tangent.

- Updating the 40 Act to bring in non-registered public investment vehicles (Hedge Funds) and making sure the role of insurance is understood in securities regulation. Again. No major problem here, but why not look at the whole regime? The hedge fund industry grew up because of the sclerotic nature of 60 year old Investment Company rules. Why not try to understand why the current regulations are so burdensome first? Then, try an overall fix? Isn't this what you should be studying? Isn't this what modernization was supposed to be about? We need MORE funds available to the public, not just a few Fidelity behemoths. See earlier point on Sabanes, Oxley and Spitzer. We need to increase the diversity and activity of equity market participants, not pass rules that stifle the capital markets.

- Credit Rating Agencies. Yes. This is an area that WAS ACTUALLY RELATED to the financial crisis. Of course, without a market-aware approach, it is far from certain that any outcome of this legislation will be positive. The idea of a government actor picking which agencies should provide ratings strikes me as inherently flawed. The reality is that money has to come from somewhere to do the work of rating, and this bill's sop to the plaintiff bar will only increase the cost of research and likely lower its utility. In previous writings, I have proposed something similar to what the National Research Exchange got approved -- a private clearinghouse that handles settlement and establishes mechanisms to avoid conflicts. These are the kinds of measures that could readily get true bi-partisan support and are truly needed changes. Why not focus the legislation on these things? Why bring in the trial lawyers? Why not encourage multiple rating agencies and let smart, institutional investors make their decisions based upon reputation and track record? Again, go ask your mother.

- Executive Compensation and Corporate Governance. Based on nothing more than Paul Krugmanesque Pablum, this bill seeks to federalize state corporate law. I have many issues with state corporate law, but this bill is not the time or place to address these issues. Perhaps a commission on best practices or model codes. Ironically, the anti-shareholder bias of corporate laws coming out of the First New Deal produced the perverse, pro-management incentives we have today. I'm all for strengthening shareholders rights, but these same liberals are jumping up and down about corporate takeovers and want to put private equity and leveraged finance (two major friends of shareholders) into the penalty box. This is an example of the kind of confusion and contradiction that is littered throughout the bill. On the one hand, class warfare rhetoric and a criminalize business and finance mentality borne of envy and ignorance. On the other hand, a few long overdue, but misplaced, changes. Very. Bizarre. Indeed.

- SEC improvements. Ha! This band of miscreants bring up Madoff, who was a major contributor to all their campaigns. The changes suggested are hardly objectionable, but the short shrift they give to the SEC is indicative of the fact (a) they do not trust markets and (b) traditional "Wall Street" had a lot less to do with the crash than the committee reports own rhetoric suggests. This bill envisions a non-market, cryptic uber-Regulator, such as the Federal Reserve, to overlord over all institutions (see below). So much more irony I can hardly take it.

- Securitization. Again, more grating "spin" about companies "selling mortgages to people they knew could not affort to pay them". Excuse me !!! Wasn't that the point of all the affordable housing mandates the government trafficked in? And what about personal responsibility that the majority pretends to talk about now? I dumped my last bonus in to pay down part of my mortgage instead of going on vacations, etc. My neighbor got a principal readjustment and then took off for two weeks to Florida. Why don't you ring up all the behavioral economists and ask them about that "nudge". As for the skin in the game rules, they are not on the face objectionable, but shouldn't institutional investors police this? Shouldn't the market just price up pure agented deals? Again, this is another half-arsed example of a junior staffer that read an article in some weekly news magazine and thought why not? No research. No thought. No discipline. No considered viewpoint. Just a probably dumb idea, we have to live with for the next several decades.

- Municipal Securities. Fair enough. Even a broken clock is right twice a day, and maybe this is one of those times.

- Strengthening the Federal Reserve. This reads like some inside baseball. Or settling some old scores. Tough to tell. The job of the federal reserve in my view is currency. Period. The fed should be subject to full audit. Period. While it is apparent that the $1T purchase of long-dated securities by the Fed in February 2009 accomplished what an ill-conceived TARP could not -- monetize the Fannie / Freddie mess -- we will live to regret the day the Fed believes its new found power should be permanent. With the collapse of the Euro, we now have a Fed that believes monetizing debt might be a palatable solution. In general, this bill heads us in the wrong direction.

Dodd Financial Reform

Posted by CleanGovernmentNow at 5/21/2010 6:19 AM | Add Comment

Are We At Farce Yet? The Show Trial of Goldman Sachs

What could possibly be more tragic than a 1400 page financial reform bill written by some of the key architects of financial ruin: Chris Dodd, Barney Frank and Timothy Geithner ?

How about a convenient show trial for Goldman Sachs, one of biggest beneficiaries of the bailout these clever men cooked up?

Yes, folks, we are on to the farce portion of the meal.

It was Karl Mark who wrote that history repeats itself: first as tragedy, then as farce. It was tragic when the Bolsheviks slaughtered the ruling elites of Russia. It was a farce when these same Bolsheviks were subject to Joseph Stalin's show trials.

Today, we have a new kind of political show trial in our midst. It follows on the heals of a financial tragedy.

On the one hand, you have a handful of elite, well-connected financial intermediaries and their investing clients that loaded up on smart gimmicks that were too clever by half. These derivatives instruments went poof when underlying real estate values declined more than expected. In a normal world, this would mean those dabbling in these hot potatoes would get burned. But lo and behold, these cats, who are perfectly capable of fattening themselves up for slaughter, were saved from their own idiocy by the bailout of their chief casino on credit -- AIG.

That was the tragedy. It is a tragedy that continues with an effort by Dodd, Frank, Geithner to play house to the Wall Street whales -- for a cut of the take of course.

Now comes word that one of the main beneficiaries of the AIG bailout -- Goldman Sachs -- might have done something that might have looked like something that might be connected to something that could possibly be interpreted as greedy speculation.

I will let the judicial process pass judgment on whether Goldman Sachs hid the ball from some highly sophisticated investors and whether our cop on the street -- the SEC -- owes it to these big wigs to fight the fight on their behalf.

What I do know is that the timing and subject matter has all the earmarks of a show trial meant to distract from a far greater set of sins that took place within the government before, during and after the financial crisis.

Posted by CleanGovernmentNow at 4/19/2010 9:36 PM | Add Comment

Oh Behave Again!

There are two species of behavioral economists - those that mostly ignore classical economic theory and manage to accomplish some interesting tasks and those bent on disproving classical economic theory. The latter often fall in to the same confirmatory fallacy they are apt to criticize in others. Furthermore, they rarely extract the most powerful findings apparent in their research, as they are more hung up on disproving than proving.

The first category are talented observers and usually good reads. The second slip easily in to politicized amateurism.

Unfortunately, with respect to our new ruling class, the second formulation appears to have won the day.

http://www.weeklystandard.com/articles/nudge-nudge-wink-wink

Posted by CleanGovernmentNow at 4/14/2010 9:39 PM | Add Comment

Hart and Zingales - Chicago School 2.0 speaks

Hart and Zingales propose a Risk management methodology for regulators.

I like it, but is it idiot-proof enough for those that we would depend upon to implement it?

Posted by CleanGovernmentNow at 3/30/2010 8:20 PM | Add Comment

O-Care - A Good Government Advocate's Nightmare

As Nancy Pelosi proclaimed: Let's Pass the Bill to Find Out What is In It

Now that the bill has passed, we can check out the pig in the poke.

The essence of O-Care is quite simple: Health insurers are now de facto Government Sponsored Entities (GSEs) by virtue of extensive federal regulation of the terms, conditions and comparative rates health insurers can offer. The law tells insurers how to run their business and then offers to pick up the cost where conditions prove uneconomic. Hmmmm. If this all sounds a little dodgy, your instincts are correct. We tried this kind of experiment in housing with GSEs: Fannie Mae and Freddie Mac, which were pressed to buy non-economic sub-prime loans dressed up by intermediaries to look respectable via bundling and shaky insurance.

This secondary market "nudge" by the government was a major reason for the bubble and subsequent collapse of the financial system under the weight of $2T of bogus AAA securities. Expect similar results from health insurers who will look a lot like the housing GSEs going forward. Fannie Mae and Freddie Mac started with a modest mission to help first time home buyers and morphed into near monopolies in the residential home market ... which then collapsed.

It gets even worse with O-Care. Housing is real property with an underlying intrinsic value unrelated to human behavior. Medical expenses are consumer expenditures with no floors or ceilings and highly susceptible to behavior signals. Extensive regulation will mean only a few "too big to fail" mega-insurers are likely to survive -- and for how long who knows. With fewer competitors, the prices go only one direction: UP. Americans will not put up with rationing, and they have come to expect the best care in the world, so any pretense of cost controls is just that: pretense. O-Care only expands the cancerous dynamics of the third party payer and deploys a few cynical heartstring pullers to create more of a sense of entitlement to be paid for by the ever diminishing "other guy".

Obamacare Day One

And what about HSAs and other consumer-driven ways to reduce costs? They are scheduled to fade in to the sunset. That is Washington: the bad ideas stick around like venereal disease. The good ones just ride off into the sunset like good soldiers who served us well, but whose time is too brief. Instead, we are left with a system that appears to be ready to fail by design, as the individual mandates necessary to pay for the new government mandates whither.

More disturbing is that the comparative effectiveness of medical treatments will not be determined by medical practitioners and their patients, but rather Gucci-garmented lobbyists. If you want your procedure or technology to be validated by "the system", do not bother to win the battle in the marketplace -- at the hospitals, conferences and universities -- make sure to spend your time and money in Washington, where the real decisions will be made about what "works" and what does not work.

Beyond the inevitable failure of central planning, the unavoidable increases in premiums and overall costs, the abdication of personal responsibility and cost control through choice and consequences, and the likely reduction of successful private initiatives, the ultimate victim will be the quality of our health care.

It has only one direction to go and that is DOWN.

If you liked what Fannie Mae and Freddie Mac did to the mortgage market and the world financial system, you will LOVE Obamacare.

Posted by CleanGovernmentNow at 3/24/2010 9:32 PM | View Comments (4) | Add Comment

Ohh Behave !

Dan Ariely (Predictably Irrational) belongs to a wave of authors doing well in airport bookstores with tales of offbeat psychological experiments and “I told them so” observations on the Great Meltdown. But while Black Swan and Blink tip a hat to the dismal science (the “invisible hand” of Taleb's fractal mathematics and surprising precision of Gladwell's subconscious), Ariely demands a tabla rasa on economics.

The raison d’etre of behavioral economics per Ariely is that traditional or neo-classical economists mistakenly assume rational economic actors, whereas neuroscience just can’t stop discovering ways primordial wackiness gets the best of cool headed calculus. Whereas certain emotional traits may be adaptive for a nomadic tribesman spearing both dinner and enemies, they are just so much baggage when calculating costs and benefits in a modern market economy.

And thus it follows that all kinds of hell -- from Enron to Subprime Mortgages -- can break loose without "regulation" (whatever that might entail). If there is any utility in classic economics, Ariely does not let us in on the secret. There is a Da Vinci Code-esque allusion to the lost meaning of Adam Smith and other seminal economists, but if you follow Ariely to his logical conclusion, even the good old supply/demand intersection should be tossed on the scrap heap, along with all the apparently illusory trades on Wall Street.

In fairness, there are several fascinating observations in Ariely’s book, and I would recommend checking out one from the library or borrowing one from a friend. Putting methodological quibbles aside, the problems begin when Ariely uses his amalgam of idiosyncratic observations to generate policy suggestions. Despite his prowess examining judgment and decision making related to chocolates, black pearls, basketball tickets and aroused libertarians, he rivals the most hide bound and assuming economist when it comes to his parenthetical hope for government actor benevolence and competence.

If market actors act irrationally with something valuable at stake, why on earth would you assume that a government actor with (a) nothing at stake, (b) benefiting from sovereign immunity and tenure, and (c) imbued with a monopoly on the legitimate use of force would be anything other than an id-driven psychopath. Not that I believe all, or even a majority of, government actors are as I just described. But if you are building a matrix of possibilities, there's plenty of evidence to fill in at least one such quadrant (Idi Amin, Stalin, Saddam Hussein, Hitler, Caligula, Katherine the Great, not to mention "Going Postal" at the lower echelons).

Ariely's recounting of the financial crisis mysteriously evades reference to existing regulations or the pressures banks faced to make uneconomic loans from those well-intentioned regulators. He also avoids the big question: would Countrywide have made so many low down payment loans if Fannie Mae and Freddie Mac -- two hyper-levered government creations -- had not "nudged" the market by buying bundled versions (RMBSs) in the secondary market, while overlooking shaky default insurance (CDSs)? And this without going in to problems of regulatory capture and evidence of out and out fraud and corruption. Yes, I'm talking Senator Dodd and Freddie Mac board member Rahm Emanuel. A refresher with J.C. Scott might remind Ariely of the cognitive fallacies (and often fantasies) that inhabit the minds of our public servants.

Behavioral economics is a valuable addition to the intellectual landscape, but it has a long way to go before public policy makers should throw away classic economics or just assume their own benevolence. Well-functioning markets have been shown time and again to be good at their main task: price discovery. Like democracy, the genius of a market is not that its makes the best choices, but that it delivers a method to eject the really bad ones.

I also found it probative that many of the experiments Ariely cites deal with status and luxury choices amongst a leisure-imbued set of college students facing little actual consequence or criticism. Perhaps more mundane studies, such as the price of corn tortillas, dishwashers, fasteners or bauxite, and hard penalties for bad choices, would be additive to the overall body of work, if less amusing for undergrads. I am thinking of the opening scene of Ghostbusters where false answers elicit an electric shock. Further, at what point does manipulation and failure to meet SEC-style total disclosure (including omission of material facts) come in to play with these many experiments? Three card monty probably not, but still ...

Bottom line: I would like to see more effort put in to reputation theory by Dan Ariely and economists like him. It IS bad social science to assume markets automatically work (or that they are "free"). But what skews a market? What trust mechanisms are needed to create honesty and transparency? How do you get information in to the market and who pays for that? How do you best police misrepresentation? Ariely teases us with a few trust mechanisms (Chapters 11-12) and mentions transparency in passing, but he does little other than pull a few pedestrian thoughts of the Newsweek genre. Ironically, he heartily acknowledges the failure of the stilted behavioral rules of the kind his regulators traditionally rely upon. I'm not sure the NYT would have permitted him on the best sellers list if they realized his most productive advice would appear to be using the Ten Commandments as a screensaver ...

So let's move on from the playing cards, Hershey kisses, Harry Winston baubles, and busty magazines, and start to get serious about fixing our real markets.

Posted by CleanGovernmentNow at 7/18/2009 5:36 PM | Add Comment

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