Our mental models and the financial crisis

Cover of "The Divine Right of Capital: De...

Cover via Amazon

Marjorie Kelly, in her book The Divine Right of Capital, constructs a bold critique of the role that stockholders play modern corporations.     She compares stockholders to the aristocratic feudal lords of yore, who made rent on “assets” into perpetuity without lifting a finger.  Instead, Kelly argues that both the employees who work to create corporate wealth, and the communities that provide the resources necessary to create that wealth, should earn a larger share of the wealth.  Kelly examines the framework of the corporation as it was first conceived, how the corporations in the United States were initially granted state charters to only serve the public good, and how that public purpose was eroded in our courts.  Examining the state of affairs today, Kelly concludes that all players, including stockholders, CEOs, Wall Street firms, and even you and I, are all complicit, but no one is guilty:

“We fool ourselves if we think we can find the enemy somewhere.  Our anger at the system leaves us like the farmer in The Grapes of Wrath, who when his farm was repossessed couldn’t find anyone to shoot.  There isn’t anyone to shoot.  The problem is our internal maps, and rethinking those can require some vilification of outmoded views.  But we must remember that we’re vilifying the value system of wealth discrimination – not the wealthy themselves.  Respect for the right to attain wealth is integral to the American psyche.”  (Kelly 99)

Kelly is absolutely right here; we all operate based on the internal maps, with their arbitrary assumptions and logic, to try to make a good life for ourselves.  Certainly, when one examines the litany of shenanigans that occurred in the recent financial crisis, it is easy to spot villains like Bernie Madoff; when reading deft accounts of the crisis, like Michael Lewis’s The Big Short, it is easy to ask how our economic game could be rigged as it is, and how we could have been so blind to the massive speculative bubble that would take down the global economy.  However, Lewis’s narrative is perhaps the most relevant to Kelly’s critique here, because the 20 or so people that saw the asset bubble for what it was were outliers, consistently critiqued by the establishment.  Their mental models were slightly off from the mainstream, most memorably Michael Burry, the one-eyed medical school graduate who was obsessed with the stock market from the age 12, and built a successful stock-picking blog that he wrote in the wee hours as a resident into his own hedge fund.    However, the majority of operators in our economy are simply following the rules of the game, to the best of their ability.  The idea of the American dream, which is echoed whenever a mother tells a child, ‘you can do anything you want,’ is a critical part of the American psyche.  Kelly is attempting to shift our mental models, so that we can see that our current paradigm doesn’t quite live up to the ideals of that American Dream; we are not the ‘Land of Opportunity’ we think we are.

Kelley identifies a critical fault in the current paradigm: the idea that shareholders ‘own’ the company, and the companies they own are required to maximize shareholder return above all other concerns.  Employees, who’s knowledge and ideas create the wealth of the 21st century, should under that paradigm be paid as little as possible.  However, Kelly brings a different mental model to bear:

“The principle is simple: efficiency is best served when gains go to those who create the wealth.  Thus, instead of aiming to pay employees as little as possible, corporations should distribute employee rewards based on contribution – while recognizing that in any humane social order, a living wage is the basic minimum.  Likewise, corporations might aim for a decent minimum stockholder gain but drop their focus on maximum gain.  The legitimate goal is reward based on contribution.  Since the contribution of stockholders has shrunk dramatically, their gains should shrink also.  It simply defies market principles to continue giving speculators the wealth that employees create.” (Kelly 108)

In light is the recent Global Financial Meltdown, it is helpful to consider what role those speculators played in the inflating asset bubbles, and the growth of subprime mortgage bonds into the dominant investment vehicle between 2005-7.  But step back for a moment and consider what would have happened if the rising productivity of the last decade were not entirely bequeathed to stockholders, but if employees got their share?  What if communities, instead of giving tax breaks to draw corporations like Boeing to move, instead received their share, and invested it in our crumbling infrastructure and public schools?  In short, both individuals and communities would bear some of the fruit of their own industry.  The system would be more efficient, and given the recent speculative disasters, we certainly wouldn’t be any worse off.

 

Works Cited

 

Kelly, Marjorie. The Divine Right of Capital.  San Francisco: Berrett-Koehler, 2003.  Print.

 


A Review of The Weather of the Future

Heidi Cullen, author of the new book The Weather of the Future: Heat Waves, Extreme Storms, and Other Scenes from a Climate-Changed Planet, has a background rare for any research scientist, let alone a climate scientist: she worked for The Weather Channel, and gained a lot of expertise in communicating complex climate science to the lay person.  This work has given Cullen a unique understanding of where misunderstandings of climate science exist:

“This is the only way a lot of people can truly connect to the issue of climate science – via a long-term investment like real estate.  The more I thought about this question, the more I realized the scientific community had failed to communicate the threat of climate change in a way that made it real for people right now.  We, as scientists, hadn’t given people the proper tools to see that the impacts of climate change are visible right now and that they go far beyond melting ice caps.”

Cullen’s new book aims to provide those tools.  She explains some of the big reasons (single-action bias and the ‘finite pool of worry’) why many Americans understand the dangers of climate change, but not urgently enough to change our behavior.  More importantly, she explicitly separates the concepts of ‘climate’ and ‘weather’ and shows how the former shapes the latter.  Cullen’s writing reminds me of Michael Lewis’ The Big Short, when she shows how climate science developed and where it stands today: she eloquently and economically conveys the complex science in a way that is pleasurable to read.   The groundbreaking part of Cullen’s book what comes next: she picks seven of the most at-risk locations around the world, explains how climate change is already impacting the weather, and uses state-of-the-art models to create climate projections for each of these places into the next half-century.  Two of the locations really hit home for me: Cullen examines the Central Valley in California, as well as New York City.  She also looks at the Sahel region of Africa, the Great Barrier Reef in Australia, the Arctic, Greenland, and Bangladesh.

Cullen borrows a metaphor from Paul Saffo, a technology forecaster who was among the first in Silicon Valley to take Y2K seriously: “Imagine you’ve got a sailboat and you’ve got to sail around an island.  You can start to circle when you’re a mile from shore and it will be easy.  But if you wait until you’re only 100 meters away, there will be rocks and reefs.  There will be a lot more drama.”  In her analysis of these climate hot spots around the world, Cullen makes clear the economic impact of waiting until the proverbial sailboat is close to the rocks and reefs.

The Weather of the Future lays bare the unequivocal nature of climate change, and the need to take actions, what Cullen calls “a million boring little fixes.”  In time, we will all make these fixes; the question for policy makers, skeptics, and citizens in general is, are we going to wait until those fixes become all the more expensive and painful?  This book is timely and necessary.


We didn’t see it coming?

I bet you didn’t think Robert Rubin and Lloyd Blankfein could sing this well!  Well, the Gregory Brothers, mavens of Autotune the News, produced this video together with the investigative reporters at ProPublica and the journalists at NPR’s Planet Money.  Their story on the actions of CDO managers at Merryl Lynch, Bank of America, and Citigroup identifies people who actually saw the financial mess coming and made it worse to make a few bucks for themselves.  This story pairs nicely with Michael Lewis’s The Big Short.


Book review of Michael Lewis’s The Big Short

Michael Lewis is one of the best storytellers around, and he brings his writing gifts to the arcane world of economics.  His catalogue features the classic Liar’s Poker, as well as Moneyball and The Blind Side, where he analyzed two of our most poplar pastimes through his economic lens.  Lewis tells the human story brilliantly; not only do you learn how markets work or don’t work, but you see how it affects the actors from an emotional level as well.  In short, even for the layman, Lewis conveys deep economic truths about complex matters, effortlessly.

There have been many attempts to catalog the Great Economic Crisis of 2008 thus far, from brilliant economists and journalists.  However, Michael Lewis’s The Big Short probably captures the most essential part, in his trademark fashion.  Lewis takes us inside the lives of the outliers who foresaw the Mortgage Bubble inflating, and bet all their chips against all of Wall St. and our economic paradigm at a time when almost no one agreed with them.  The characters in this story spring to life as if out of a great novel, but given the fact that this story is still so recent, the raw emotions of the events are still affecting them, as well as the reader.

Hindsight is 20-20, but it is too easy to look back at Michael Burry, the unlikely head of Scion Capital, who first predicted this catastrophe back in 2003, and wonder, why didn’t we all see this coming?  Of course for Burry, Steve Eisman, Greg Lippmann, and the few that made a fortune when the bubble popped, this was not an easy payday.  They struggled with their bets, both in the face of skepticism and in their unwillingness at times to believe that the powers that be would really let the subprime mess happen.  Once Bear Sterns failed in 2008, and the dominos started falling, the events happened fast, and the heroes in this story were left wondering if the country would even survive.

Lewis captured the heart of the biggest story of our time.   This book is a great pleasure to read, even through we are all still suffering the consequences of the crisis.  This may be his best book yet.