The Boom/Bust Cycle Isn’t about Emotion

My first experience with manias was in the 1950’s. As a pre-schooler, I was dragged along to the Filene’s Basement annual designer dress sale. Thousands of women of all types and sizes pressed against the glass doors opening into the subway station. Within minutes of the doors opening, these “maniacs” cleared all the racks and, holding armfuls of dresses, began stripping to their slips. That’s when I panicked.

Looking back, those women acted rationally. There was a limited supply of deeply discounted dresses available on a first come basis. They traded among themselves to get the right size and their most desired dress. Buyer’s remorse was cushioned by Filene’s liberal return policy.

The premise of U.S. financial regulation is that actors within private markets are irrational, but the evidence shows that it’s not maniacal, illogical behavior that sends markets into freefall.

Great Depression and Recession

Now in its seventh edition, Manias, Panics and Crashes: A History of Financial Crises, Charles Kindleberger’s seminal work provides the narrative that underlies virtually all public financial protection and regulation: First, the irrational exuberance of individuals transforms into “mob psychology” and fuels an asset bubble. Then, when the exuberance of a few turns to fear, the mob panics and overreacts, causing a crash that brings down both solvent and insolvent financial institutions.

In his memoir, the former Federal Reserve Bank President and Treasury Secretary Timothy Geithner, who was at the epicenter of the last crisis, concluded, “It began with a mania — the widespread belief that devastating financial crises were a thing of the past, that future recessions would be mild, that gravity-defying home prices would never crash to earth.”  

Most U.S. federal financial regulation originates from the Great Depression and the subsequent introduction of federal deposit insurance provided by the Federal Deposit Insurance Corporation (FDIC), which was established in 1933 to protect “small” savers. All prior state attempts to provide insurance failed. Because there were no effective, non-politicized regulations that could prevent the moral hazard of insured banks and savings institutions taking on excessive risks, an extensive regulatory infrastructure was put in place.

Rational Actors

Now, the U.S. has about 100 financial regulators, including those in the U.S. Treasury and the Securities and Exchange Commission (SEC), the FDIC, and the Fed. With near-universal deposit insurance, bank runs have become a rarity, but systemic crises have occurred more frequently. It is incontestable that big bubbles eventually burst, asset prices crash, and financial crises ensue. What causes the bubbles to inflate to systemic proportions, and to ultimately burst, is more contentious.

At the time of Kindleberger’s analysis, individuals were assumed to be rational. The latest edition of his book, written after the 2008 financial crisis, postulates numerous theories about mob psychology (mania) that could lead rational individuals to produce irrational markets, but these ideas are all rather lame.

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“More Trump”

Assistant Village Idiot:

Consequently, the standard for avoiding mistakes is now the same for you as you have been applying to others for your whole career. When accusing Trump of making some inaccurate statement, if you get that wrong once it outweighs nine times that you got it right. And, just between you and me and the lampost, you aren’t close to getting it right 90% of the time just now. so in the minds of the public, you are digging yourself in deeper and deeper. Fresh examples are best. There was a lot of excitement this past weekend about Trump claiming something had gone wrong in Sweden, but there hadn’t been any big incident that anyone could recognise. When I first read it, I thought What the hell is Trump talking about there? I thought the story plausible, because Trump does stuff like this. Then I saw the transcript, and without even knowing the rest of the story, I thought Unh, there’s some window there. It’s a little clumsy in the wording, but he could be talking about events in general in Sweden, maybe an “Every Friday night…” You shouldn’t try to slam dunk these, because they keep hitting off the rim. So when I read the full response, that Trump had watched Tucker Carlson on the news Friday with a story about the increase in rape and violence in Sweden due to immigration, it made entire sense.
 
The people who always believe you – the people who will believe any bad thing about Trump (and his minions – don’t forget his minions) will throw up their hands, roll their eyes and say “Aw come on, that’s a ridiculous excuse. You got caught out, you old windbag. Don’t try to bring that crap in here.” Except it’s not ridiculous at all. That’s exactly how Trump talks, and how he thinks. He’s been talking like this for years. His claim is entirely plausible. It not only could be true, so you can’t get your slam dunk, it is actually the most likely thing that happened. Because why the hell else would Sweden suddenly occur to him? The news story was in his stew, it bubbled to the top, and he spooned it.
 
Net result: Your pals, no change. They still don’t believe Trump but even if he had some sort of definite proof they would just scowl and wait for the next time. (We’ll get him next time.) Trump’s pals, no change. Even if you had proof they’d just shrug it off. People in the middle, that one-third of the population, most will now remember They lied about Trump again, about something really small and pointless like it was a big deal. Maybe a few will think you scored a point, but also notice that it doesn’t much matter. Small potatoes. So now you need to catch him nine times, without a miss, to make up for it. Welcome to the world you made. How does it feel to be on the receiving end?
 
Remember the first rule of holes.

Worth reading in full.

The Deep State will not go easily.

Several years ago, I posted an account of what is called ‘The Deep State.”

There is the visible government situated around the Mall in Washington, and then there is another, more shadowy, more indefinable government that is not explained in Civics 101 or observable to tourists at the White House or the Capitol. The former is traditional Washington partisan politics: the tip of the iceberg that a public watching C-SPAN sees daily and which is theoretically controllable via elections. The subsurface part of the iceberg I shall call the Deep State, which operates according to its own compass heading regardless of who is formally in power.

That article was one of several around that time (2014) about the Deep State.

History suggests that this low-intensity conflict within the ruling Elite is generally a healthy characteristic of leadership in good times. As times grow more troubled, however, the unity of the ruling Elite fractures into irreconcilable political disunity, which becomes a proximate cause of the dissolution of the Empire if it continues.
I recently proposed the idea that Wall Street now poses a strategic threat to national security and thus to the Deep State itself: Who Gets Thrown Under the Bus in the Next Financial Crisis? (March 3, 2014)

That didn’t happen but the Deep State is in the news again as an enemy of Trump.

It stands to reason that “the Swamp” he talked about draining is coterminous with “The Deep State.”

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The Revolt Against the Experts

‘Trump makes sense to a grocery store owner’

Economist-mathematician Nassim Nicholas Taleb contends that there is a global riot against pseudo-experts
 
After predicting the 2008 economic crisis, the Brexit vote, the U.S. presidential election and other events correctly, Nassim Nicholas Taleb, author of the Incerto series on global uncertainties, which includes The Black Swan: The Impact of the Highly Improbable, is seen as something of a maverick and an oracle. Equally, the economist-mathematician has been criticised for advocating a “dumbing down” of the economic system, and his reasoning for U.S. President Donald Trump and global populist movements. In an interview in Jaipur, Taleb explains why he thinks the world is seeing a “global riot against pseudo-experts”.

Taleb has a typically thoughtful and contrary take on Trump’s electoral victory. Worth reading in full.

(Via Peter Saint-Andre.)

Glasnost and Perestroika: An Agenda for the Trump Administration

Although President Trump is confident of his ability to deal with Vladimir Putin, he should carefully avoid emulating Putin. It would be far better for the president to look to the example of Putin’s predecessor, Mikhail Gorbachev, who transformed the Soviet Union. The first steps in the transformation were glasnost and perestroika. Glasnost, introduced in 1985, roughly means openness and was a step toward open discussion of political and social issues. Perestroika, introduced the following year, roughly means restructuring. Perestroika reduced central economic planning and allowed some private business ownership. These and later reforms resulted in a sharp increase in political freedom (from nil), which peaked in 1991. Sadly, the gains were short lived. Freedom steadily and drastically declined under Yeltsin and Putin for a complex of reasons debated at a recent symposium at the Cato Institute.

The United States as it emerges from the Obama Administration, while not as bad off as the Soviet Union as it emerged from communism, is badly in need of both glasnost and perestroika. They should be the twin priorities of the dawning Trump Administration.

Glasnost

The American left has come to despise freedom of speech as much as it has traditionally despised freedom of contract. It has followed the normal progression of leftist movements toward viewing the protection of its social objectives as more important than human rights. The earliest and still worst manifestation of this trend is on college campuses. Campus speech codes began to appear in the late 1980’s and spread rapidly. Within a few years sixty percent of colleges had them. According to a report of the Foundation for Individual Rights in Education, the percentage has declined over the last nine years to forty percent.

In 1998, Congress declared that it was the sense of Congress that “an institution of higher education should facilitate the free and open exchange of ideas” and that “students should not be intimidated, harassed, discouraged from speaking out, or discriminated against.” 20 U.S.C. § 1011a(a)(2)(C), (D). While the sponsors of this provision may have thought (or wanted to give the impression) that they were doing something, they did not do very much. The provision imposes no consequences on institutions that act contrary to the sense of Congress on this subject. It needs an amendment putting federal funds at stake, as anti-discrimination sections in title 20 do. Although speech codes are less common than they were, universities still do a lot to stifle “the free and open exchange of ideas.” In particular, they fail to prevent students from being intimidated, harassed, and discouraged from speaking out by other students, using increasingly violent methods.

Intolerance of dissent, especially on a fixed dogma like climate change, is not limited to college campuses. A few years ago, a cabal of environmentalists enlisted sympathetic state attorneys general to investigate climate change dissidents. With a vague objective of finding a RICO violation, a group of twenty attorneys general (“AGs United for Clean Power”) have subpoenaed forty years of records from ExxonMobil in a retaliatory effort to find evidence that it has had information on climate change that differs from what it has said publicly. The attorney general of the Virgin Islands subpoenaed documents from academic institutions, scientists, and the Competitive Enterprise Institute, a think tank. He withdrew that subpoena after getting some pushback from a congressional committee and a lawsuit from the Competitive Enterprise Institute.

A venerable weapon is available for the Justice Department to use against oppressive state universities and attorneys general, the Enforcement Act of 1870. The second section of the act, 18 U.S.C. § 242, makes it a crime for anyone under color of state law to deprive a person of rights, privileges, or immunities secured or protected by the Constitution. The first section of the act, 18 U.S.C. § 241, provides criminal penalties for conspiracy to injure, oppress, threaten, or intimidate any person in the enjoyment of any right secured to him by the Constitution. State action is not an element of the crime under § 241. Could not the Civil Rights Division of the Justice Department, under new leadership, go after, for example, a group of students who prevent Milo Yiannopoulos from speaking? That would be fun.

These tools may or may not work, but they should be tried. Assaults on civil liberties should no longer be costless.

Perestroika

In Federalist No. 72, Hamilton said, “To reverse and undo what has been done by a predecessor, is very often considered by a successor as the best proof he can give of his own capacity and desert.” This has to be the best standard now, as everyone in the Trump Administration should understand.

Perestroika in the modern context ought to begin with reversing and undoing the Obama Administration’s impositions on the economy. Amity Shlaes, who, it should be recalled, wrote The Forgotten Man, observed that “smaller firms–the ones unready for the lawsuit, the investigation or the audit–bear the greater share of regulatory costs.” The regulatory burdens in need of repeal extend far beyond the Affordable Care Act and its progeny. Daniel Pérez of George Washington University’s Regulatory Studies Center has determined that Obama issued about 33% more “economically significant” regulations than either Bill Clinton or George W. Bush.

It will be a challenge for the political appointees in all the departments of the federal government to sift through the regulations and begin the process of liberating the economy from the worst of them. Fortunately, litigation has already left some of the Department of Labor’s output in ruins. The Persuader Rule, which I warned about in this blog before its adoption, and the Fiduciary Rule are controversial intrusions of the Labor Department into professional relationships. Both the Persuader Rule and an anti-business revision of overtime regulations have been enjoined by federal district courts in Texas. Five different lawsuits challenging the Fiduciary Rule are pending.

Withdrawing appeals of the rulings against the Persuader Rule and the overtime regulations is the simplest way to dispatch those rules. Other recently adopted regulations can by nullified by using the Congressional Review Act, 5 U.S.C. § § 801-808. A joint resolution of disapproval has to be introduced within sixty days of Congress’s receipt of a report of rulemaking. The act provides an expedited procedure for a joint resolution and limits debate in the Senate. In June, President Obama vetoed a joint resolution disapproving the Fiduciary Rule.

For that rule, and so many others, the arduous notice and comment process of the Administrative Procedure Act will be the only method of repeal. The ultimate goal should be that the Code of Federal Regulations will bear no trace that the Obama Administration ever existed and, more generally, that this time glasnost and perestroika will have a more lasting imprint.