Archive for the ‘moral hazard’ Category

Part 4 Dialogue on Moral Hazard, fixing the financial sector and certainty of knowledge:

September 25th, 2013 No comments

Cross-posted from “we build our society” Facebook group:!/groups/webuildoursociety/permalink/426598337444055/

Terry, 2007-09 flow from various government interventions, not limited to those I just outlined, that served the purpose of blowing a bubble and freeing those playing with money from personal responsibility. This meant that smart men focussed on how they could game the system for their own profit. It happened continually and is still underway, though 1994 in Boca may be a good example.

Doug, [Jekyll Island 1913] was just the creation of the Fed (and just part of my item(3) above); the roots go much deeper to other state interventions I noted. The pre-Fed booms/panics also flowed from the state-level creation of banks as corporations and monopolies, and interventions to save banks that essentially broke promises to depositors by creating un-backed paper money. See Rothbard’s History of Money and Banking in the United States,

Categories: banks, limited liability, moral hazard Tags:

Part 3: Dialogue on Moral Hazard, fixing the financial sector and certainty of knowledge

September 25th, 2013 No comments
Cross-posted from the “we build our society” Facebook group:
Terry, yes the entire financial sector is rotten/corrupt and rife with moral hazard. And things are now WORSE, as the banks are now TWICE as large as they were previously, and banking reform has served to squeeze smaller banks out of business…. Most of the approaches you suggest would be worthwhile (as would heads on pikes), but none of them actually address the roots of the moral hazard–
(1) the centralizing/federalizing Deposit Insurance by which Govt pretends to “protect” us, but instead builds a regulatory house of cards that puts the robbers in charge of the larger banks, and ultimately leads to taxpayers holding the bag when the bank fails or the “unexpected” but entirely natural/predictable “crisis” occurs and forces “responsible” pols/bureaucrats in DC to bail out the firms whose employees/managers/execs have done all the looting,
 (2) the federal effort (on behalf of favored elites) to take control of the money supply,
(3) the state/federal replacement of paper money as redeemable warehouse receipts for physical currency with just IOUs (and now backed by nothing), as long as the bank maintains “reserves” of cash or “secure assets” like federal bonds (so that the govt can loot the banks to fund pet “public infrastructure” projects; and
(4) the state creation of banks as limited liability local monopolies in the first place (in exchange for money to the state treasury/pols hands), and the then subsequent protection of bankers (by banking “holidays” etc) when they found it convenient to rob their customers by issuing more IOUs than could be redeemed in physical currency. Limited liability has always been the core intervention.
 The Big Boys now have entirely too much power to effectively regulate on a large scale, but we MIGHT be able to pare back deposit insurance, which would restore to some savers (rather than taxpayers) responsibility for figuring out where to put their money (and would create a REAL market for bank analysis). What we also need is to offer much lighter regulation to new banks that are exempt from any federal or state deposit scheme–and let depositors and shareholders manage their own risks, as they are now doing in private companies that are avoiding the public securities markets.

How do government actions enable pollution and other social problems?

September 25th, 2013 No comments

[from a comment at the “we build our society” Facebook group]

[A]s a factual matter, the greatest Industrial Revolution pollution occurred AFTER governments started to create #LimitedLiability corporations whose effect (and aim) was to protect INVESTORS from the downside risks of doing sh*t that hurt OTHER PEOPLE.

Even today, most of our largest social problems flow from risk socialization and lack of accountability, proximately resulting from wonderful LAWS that serve the powerful, while pretending to “protect” the poor and dumped upon.

Fukushima happened because NO ONE had any personal skin in the game. What happened was no “surprise” or “Act of God”, but an expected result where NO ONE was f*cking responsible for the downsides of poor decisions that benefitted themselves or their organizations, favored corporations with monopolies, whose shareholders and lenders are protected from liability, the banks that are protected by government, the executives and regulators who often retire to the regulated company, the mega-construction firms who built the reactors, the legislators who imposed taxes on all users to bribe the local communities into accepting them ….

Where no one is accountable, bad sh*t is no surprise, but more LIKELY to occur. The same story can be written of the BP/Gulf of Mexico disaster, the ongoing oil sands disaster, coal/oil pollution, the god-damned War Machine/Prison/Industry/Drug War complex, and the “unexpected” financial crisis resulting from monetary gaming by the Fed and a gazillion regs that left depositors and shareholders powerless in the face of looting by bankster elite-wolves.

The answer is NOT “more govt!” or “more regulation!”, but SMARTER regulation that RESTORES RESPONSIBILITY and stops the lie of govt “protecting” people. Keep regulating the old/big cos, but LET THE SMALL and ACCOUNTABLE BUSINESSES FREE. Firms run by managers who are members of the communities in which they operate, and whose owners have no government-granted #LimitedLiability be kept in check by their communities and the risk of losing their personal assets, and will, via the process of #CreativeDestruction, supplant the corrupt dinosaurs.

[New & Improved links] Welcome to Big Brother III: More on the "Financial Stability Board"

December 24th, 2009 No comments

Please note my preceding posts, about the establishment of global financial governance, which has astonishingly thin coverage given its importance and implications. Has everyone been distracted?

Here is some background and discussion that may be useful, in chronological order:

G-20 Shapes New World Order With Lesser Role for U.S., Markets“, Rich Miller and Simon Kennedy, Bloomberg, April 3, 2009

Financial Stability Board Portends Economic Global Governance“, Jim Kelly (Director of International Affairs for the Federalist Society for Law and Public Policy Studies and Co-Director of Global Governance Watch), Global Governance Watch, April 21, 2009

The End of America’s Financial Independence?” Gary D. Halbert,, April 28, 2009

The Bloodless Coup of the Global Financial Stability Board: From Guidelines to Rules“,  Ellen Brown (author, “Web of Debt”) HuffPo, June 24, 2009


Financial Stability Body Could Co-ordinate Global Banking – FSA“, Reuters, Oct 14, 2009

Global banking body may be needed-FSA“, Huw Jones,, October 19, 2009

The proposed European Systemic Risk Board is overweight central bankers“,  Wlillem Buiter, Maverecon blog, Financial Times, October 28, 2009 (re: similar proposal to consolidate regulation in the EU)

“Thirty financial groups on systemic risk list“, Patrick Jenkins and Paul J Davies, Financial Times, November 29 2009

“Regulators list systemic risk institutions -FT“, Reuters, November 29, 2010

The Financial Stability Board Lists Thirty Systemic Risk Institutions“,, Nov 30, 2009

Regulators Resist Volcker Wandering Warning of Too-Big-to-Fail “, Gadi Dechter and Alan Katz, Bloomberg, December 4, 2009

is leading a chorus arguing for restricting the size or primary
functions of financial institutions. … Volcker, who heads President Barack Obama’s Economic
Recovery Advisory Board
, told Kentucky’s Georgetown College
students “we need to produce more, finance less””

What international experience tells us about financial stability regulatory reforms“, Michael Pomerleano, forum, December 21, 2009

Finally, here is a link to the publications of the Financial Stability Board itself.


Here is a useful excerpt from Gary Halbert`s piece (The End of America’s Financial Independence):

“What follows are verbatim excerpts from the G-20 Communiqué that
pertain to the new Financial Stability Board (be sure to read the
bullet points below).


failures in the financial sector and in financial regulation and
supervision were fundamental causes of the crisis. Confidence will not
be restored until we rebuild trust in our financial system. We will
take action to build a stronger, more globally consistent, supervisory
and regulatory framework for the future financial sector, which will
support sustainable global growth and serve the needs of business and

We each agree to ensure our domestic
regulatory systems are strong. But we also agree to establish the much
greater consistency and systematic cooperation between countries, and
the framework of internationally agreed high standards, that a global
financial system requires. Strengthened regulation and supervision must
promote propriety, integrity and transparency; guard against risk
across the financial system; dampen rather than amplify the financial
and economic cycle; reduce reliance on inappropriately risky sources of
financing; and discourage excessive risk-taking. Regulators and
supervisors must protect consumers and investors, support market
discipline, avoid adverse impacts on other countries, reduce the scope
for regulatory arbitrage, support competition and dynamism, and keep
pace with innovation in the marketplace.

To this end we
are implementing the Action Plan agreed at our last meeting, as set out
in the attached progress report. We have today also issued a
Declaration, Strengthening the Financial System. In particular we agree:

  • to
    establish a new Financial Stability Board (FSB) with a strengthened
    mandate, as a successor to the Financial Stability Forum (FSF),
    including all G20 countries, FSF members, Spain, and the European
  • that the FSB should
    collaborate with the IMF to provide early warning of macroeconomic and
    financial risks and the actions needed to address them;
  • to reshape our regulatory systems so that our authorities are able to identify and take account of macro-prudential risks;
  • to extend regulation and oversight to all
    systemically important financial institutions, instruments and markets.
    This will include, for the first time, systemically important hedge
    [emphasis added]
  • to endorse and
    implement the FSF’s tough new principles on pay and compensation and to
    support sustainable compensation schemes and the corporate social
    responsibility of all firms;
    [emphasis added]
  • to
    take action, once recovery is assured, to improve the quality,
    quantity, and international consistency of capital in the banking
    system. In future, regulation must prevent excessive leverage and
    require buffers of resources to be built up in good times;
  • to
    take action against non-cooperative jurisdictions, including tax
    havens. We stand ready to deploy sanctions to protect our public
    finances and financial systems. The era of banking secrecy is over. We
    note that the OECD has today published a list of countries assessed by
    the Global Forum against the international standard for exchange of tax
  • to call on the accounting
    standard setters to work urgently with supervisors and regulators to
    improve standards on valuation and provisioning and achieve a single
    set of high-quality global accounting standards; and
  • to
    extend regulatory oversight and registration to Credit Rating Agencies
    to ensure they meet the international code of good practice,
    particularly to prevent unacceptable conflicts of interest.

instruct our Finance Ministers to complete the implementation of these
decisions in line with the timetable set out in the Action Plan. We
have asked the FSB and the IMF to monitor progress, working with the
Financial Action Taskforce and other relevant bodies, and to provide a
report to the next meeting of our Finance Ministers in Scotland in


You noticed that I highlighted the key word “all” in
the bullet points above from the G-20 Communiqué. If the FSB, in its
international wisdom, considers a financial institution or company or a
hedge fund “systemically important,” it may regulate and oversee it.
This provision extends and internationalizes the recent proposals by
Treasury Secretary Geithner and the Obama administration to regulate all firms that are deemed to be “too big to fail,” in whatever sectors of the economy they so choose.”

I see NO coverage of the FSB at ANY libertarian institution (based on a quick Google; if they have, I appreciate if it is brought to my attention).

I also note that the following is relevant to a portion of the FSB agenda: Reducing Interference with Accounting Standards and Devising Securities to Price Moral Hazard, Statement No. 277, Shadow Financial Regulatory Committee, AEI, September 14, 2009

Welcome to Big Brother II: WSJ brings us "The Future of Finance"

December 23rd, 2009 No comments

Further to my prior post, I decided to take a whack at laying out the WSJ`s online report and describing some of its contents.

The master page is here – is not outlined as clearly as the Asian print edition, which is in the following order, which I`ve linked to corresponding section of the online version:

Fixing Global Finance (intro)

A Call to Action (“A ranking of the 20 recommendations at The Wall Street Journal’s Future
of Finance Initiative, aimed at rebuilding the global financial system.”) Participants were divided into four groups, each one looking at a specific aspect of the future of finance:

• How to deal with financial institutions deemed too big to fail.

• How national regulatory authorities can effectively oversee global institutions.

• How to deal with financial institutions at the regulatory frontier that act like banks but aren’t regulated as banks.

• How to address complex, innovative products, like credit-default swaps and collateralized debt obligations.

Each group came up with five top priorities for how to rebuild its area of the financial system. All participants then voted on the order of prirority.

It is useful to actually review the four groups’ discussions, which are here:

Too Big to Fail

International Regulation

Financial Innovation

Regulatory Frontier

Paul Volker: Think More Boldly

Other articles that are linked at the main page do not appear in the print edition; I will look at them later.

The top 20 priorities identified are these (my emphasis, identification of buzz words & comments):

1) Higher Capital Requirements

Financial institutions whose “systemic importancerequires national
authorities to underwrite them if they fail
[they are apparently the institutions identified here] should be required to hold
more capital.
This should include increasing risk weightings,
asset/liability limits based on the business model rather than on
simple capital ratios, as well as “contingent capital” [a form of debt that converts to equity whenthe bank is in trouble] and “dynamic
provisioning”. [“Too big to fail” has been formally identified globally!]

2) Empower the 
The Financial Stability Board [created by the G-20 in April to “address vulnerabilities and to develop and
implement strong regulatory, supervisory and other policies in the
interest of financial stability
” and supported by a secreariat in the BIS; national member organizations are here] should be empowered to define and seek
agreement on broad-based principles that national regulators should try
to make operational in consultation with market participants. [This is our new global financial overlord]

3) Promote Risk Management

should be required to demonstrate a full understanding of risks
inherent in new products.
Elevate risk managers to at least the same
level as product makers and give them adequate representation at board
. Create globally recognized qualifications for risk managers, and
implement standard certification through a risk “driving test.”

4) Improve Regulator Resources

Ensure that regulators are high quality and have deep knowledge of the
industries and institutions they oversee. Regulator compensation should
be competitive with compensation in regulated industries. Industry
should “second” senior people to support the Financial Stability Board
and regulatory bodies. [Too big to fail firms, are required to place senior execs within the regulator.]

Better Governance

Hold systemically important institutions to “higher standards of
governance”. Chief risk officers should report to the board and not the
chief executive
. “Achieve greater transparency”.[Hard to see if any of this is meaningful; in any event, firms should be governing themselves, not adding governance structures to please the state.]

Avoid Regulatory Arbitrage

To make global co-operation feasible and promote a level playing field,
regulations should be of an achievable scope. Financial activities of
similar substance and economic reality should be regulated in the same
way from country to country. [Regulation has been foisted on the industry only because governments have taken control of money supply, and insure deposits. Surely we should be talking abot restoring markets, not beefing up government. Coordination of regulation may spread systemic risk, and make larger^scale gaming possible.]

Overhaul Rating Agencies

Restore investor confidence in rating agencies by eliminating conflicts
of interest between agencies and issuers, returning to an
“investor-pays” model, distinguishing between ratings of corporate debt
and structured financial products, and promoting new entrants to the
credit-rating business. [So rating agencies are further regulated? Why not scale back deposit insurance, and end the “investment grade” requirements that banks only cared about in a check-the-box kind of way? That there is little competition among rating agencies is also due to federal fiat.]

Market Infrastructure

Create a market structure to facilitate orderly unwinding of failed
financial institutions, including greater use of central clearing. [Maybe a development that makes sense on its own, if market participants want such clearing houses. But this will be forced on every Too Big bank, and smaller institutions will likey have to follow suit.]

) Countries Should Follow the Financial Stability Board

G-20 countries should commit to implement in their jurisdictions the
regulatory provisions put to them by the FSB, without significant
amendment or supplementation. [Big Brother replaces national legislatures!]

New-Product Transparency

Improve structural and price transparency of new products, using
modeling and stress testing to ensure that downside scenarios are as
visible as upside scenarios. [Transparency is a concern that should be one left entirely to market participants; governments are simply imposing new requirements on top of those that led to gaming, profits, opacity and market freeze-up. Since when has it become the job of government to help everyone make credit decisions?”]

Regulators Adopt Priorities

Global regulators over the next 18 months should achieve agreement on
the adoption of accounting standards set by the International Financial
Reporting Standards and “appropriate capital and liquidity standards”. [Accounting standards should also be entirely private; they became public as a result of government decisions to regulate stock markets, and the reporting of “public” companies.]

Effective Enforcement

The consequences of bad actions must include real “wallet harm” in
order to be effective, and enforcement must be consistent across
national boundaries. {Big Brother controls the stick everywhere.]

Global Imbalance Focus

The G-20 should focus on resolving global economic imbalances and
integrate that process with discussions on financial stability.

Rebuild Responsibility

Regulation alone is not the cure. The financial-services industry must
show cultural leadership and promote responsible behavior by all
practitioners. [Sure, but by strengthening regulation, market self-discipline is necessarily weakened. Does siimply mouthing the words make the moral hazard of the past decades go away? The KEY problem in fuelling government intervention has been the limited liability – and loosening control – of owners, leading to risk-shifting to the public and greater internal freedom of managers.]

Strengthen Infrastructure

Ensure financial infrastructure is “commensurate with the innovation” it supports, both at the firm and the market level. [Um, isn`t this a concern solely of a firm`s owners? Why is further regulating innovation the job of regulators? Aah, “systemic risk” introduced by deposit insurance and reserve regulation! Why not step back from underlying causes?]

Resist Over-regulation
Because financial innovation is central to growth and critical to a
speedy recovery, the G-20 and successors should recognize that new
rules and protocols should not thwart innovation, and the cost of
regulation must be balanced against the benefits.[Empty words. Who is to resist, and who will have the ability to do so, in the face of a global regulator?]

Regulatory Mandate
Regulators should have a clear and strong mandate for financial
stability, and should cooperate across borders and maintain a level
playing field.

Living Wills
Systemically important banks should present regulators with living
wills demonstrating how they would wind down business in the event of
unsustainable losses. Cross-border arrangements should provide for
burden-sharing in the event of failure. [Window-dressing to reassure taxpayers that Too Big to fail doesn`t mean Too Big to fail, and bailouts.]

Don’t Regulate Borrowers
Regulators should focus on the source of credit, not on borrowers,
using [bank] capital requirements to restrict excessive leverage among
borrowers, including alternative-asset managers. [This means that Big Brother will determine how much lending goes to ther unregulated financial sector!]

Clarify IMF Role

The International Monetary Fund should focus on global imbalances and
defer to the Financial Stability Board on financial-stability
principles while continuing to have surveillance responsibilities. IMF
quotas should be revised to reflect global economic realities. [Division of labor withing Big Brother.]


As I noted previously, Paul Volker seems to have noticed that our financial system has become an enormous drag on the economy, but while he comments that the regulated need to be bolder, and that they haven`t gone far enough in addressing moral hazard, he seems completely oblivious to the role of government in aiding and abetting the moral hazard.

More than a little wrong-headed and disturbing.

That`s it from me for now. Looks like 1984 is coming in 2010.




Wall Street Journal organizes financial industry’s plan to destroy market discipline, take over regulation globally – hello?

December 23rd, 2009 No comments

[Update: My follow-up post outlines the WSJ`s report and chief recommendations.]

I thought I’d elevate what was a side and closing comment on Stephan Kinsella’s Avatar thread, about an appalling group of articles at the Wall Street Journal, which seems to have absolutely no clue about how the financial crisis stems from a chain of   government interventions, was fuelled by a government-inflated bubble and was “intermediated” by a financial industry rife with moral hazard.

The WSJ is great at drumming up fears about a world-wide climate change cabal, consisting of everyone one who showed up at Copenhagen, blogged about it or thought about it (fears of regulatory over-reach are perfectly understandable, but nary a cui bono question about the “skeptics” industry), but just what in the heck are they trying to pull here – help to CREATE world government, directed by the same firms and regulators who brought us market opacity, arbitraged investment and capital requirements intended to backstop deposit insurance, rampant profit-taking, financial meltdown and tremendous risk-shifting (to shareholders & taxpayers)? Is the WSJ really so naive about rent-seeking, moral hazard and mission creep?

I urge everyone to take a very close look at the WSJ’s “Future of Finance Initiative” and their recent “Fixing Global Finance” report.

Here’s a copy of my comment, as noted in my prior blog post (with some bracketed additions and changes to order):

What happens abroad at the “Avatar” is pretty basic, but the same
nonsense, with taxpayers, investors and consumers playing the role of
victim, can be seen at home. Has anybody seen the jaw-droppingly
appalling report that the WSJ has run on “Fixing Global Finance”, based
on their “Future of Finance Initiative”, in which they cheerlead a
bunch of financial firms in their efforts to abandon free markets and
to structure global regulation and regulators, to be staffed by a
revolving door of themselves?

[I think I’m being fair to see this as posing a threat to markets and
freedom at least as great as what others see in the more multi-faceted
climate change muddle.]

Even Paul Volker was appalled, not at
their willingness to create more regulation, but at their unwillingness
to confront the moral hazard problems (tied to regulation of public
corporations and the financial sector) that lie at the core of the
financial meltdown. [Volker seems to overlooked the crucial role of
government in driving and feeding the moral hazard problems.] Here’s the link, for those of you who missed it: Property rights, corporations and government-complicit theft? Hmm.

[Sounds familiar. Maybe some of those who want to battle corporate
excesses might not be so crazy after all, even if they neglect to
understand the risks of negative consequences of seeking help from
government. And maybe someday libertarians will get a little more
serious about addressing the festering
concatenation of corporate-linked problems that are generating so much
rot at the core of our government and public company/financial company

Corporations have very unfortunately been inescapably tainted
with statism from the get-go, in ways that play out negatively both
abroad and at home. I’ve devoted a fair amount of time to examining the
entanglement of corporations and government:

Our state governments were wrong to get into competition with each
other to grant corporate status to investor-owned enterprises, in
exchange for fees and later taxes. Corporate status freed investors
from down-side risk, by limiting liability to the amount of capital
contributed. This incentivized investors to encourage corporations to
embark on risky activities that shifted costs to innocent third
parties; the concentration of wealth in corporations (that now have
unlimited lives and purposes, subject to survival in the market); the
corruption of the court system that once protected third parties from
damages caused by others (by replacing strict liability with balancing
tests); and the ensuing battle over legislatures and courts to check
corporate abuses.

I will try to come back later and provide more details of the WSJ initiative/report, but for now let me note that I have relevant discussion at some of my posts on limited liability (see link above) and on “Rot at the Core“.

Rot at the Core: John Quiggin says that to stop banks from engaging in risky activities we need to outlaw investment banking

October 10th, 2009 No comments

I commented last week on a blog post by leftist Aussie economist John Quiggin, who blamed the financial collapse on investment banks, and suggested that either:

(i) investment banking should be much more heavily regulated (“Properly
done, regulation of this kind would kill off investment banking of the
kind with which we are familiar.”), or

(ii) ultra-high Glass-Steagall-like barriers should be raised that prevent most transactions between investment banks and government-guaranteed banks.

Right; and the identical approach to outlawing drugs and tightening penalties for buying, selling, growing and producing has worked out great, hasn`t it?  (Well, it has, for our growing and ever-more invasive armies of regulators, police, prisons, and grug-related interventions abroad.)

Such proposed “solutions” left me head-scratching, since they entirely missed addressing the root of the problem, which Quiggin identifies here:

This is one instance of a more general point emerging from discussion of the financial crisis. As
Felix Salmon observes, the extraordinary profitability of investment
bank can most plausibly be explained by the hypothesis that risk is
being shifted, without compensation, to someone else
. Salmon focuses on the case of ignorant buyers, sold products they don’t understand. But, as
Arnold Kling observes, an equally important source of investment
banking profits is regulatory arbitrage at the expense of governments,
and, ultimately, the public at large

Why not observe that government efforts to make depositors “safe” by guaranteeing deposits has instead almost entirely blown up, at the expense of taxpayers, and engendered a system of spiralling risk-shifting and opacity that left even the largest and smartest investment banks unable to calculate their own exposures and scrambling for government protection? And wonder whether – instead of banning risk-taking and providing products used for risk-shifting and regulatory arbitrage – it`s time to introduce real discipline into the system by making depositors and investors, banks and investment banks, carry a little more of their own risks?

I left John the following comment (with typographical edit)

October 6th, 2009 at 20:48 | #27

it seems to me that you`re missing an important part of the picture
(that Arnold Kling and others point to): namely, the “information
problem” that limits the ability of regulators to notice, much less
keep fingers in, all of the holes in the dike, along with the federal
interventions in banking that have provided the chief moral hazard
problems and the chief demand for the products that investment banks

BIS and investment standards created for the purpose of limiting the
risk that the government put on taxpayers via deposit guarantees
instead fuelled demands for products that provided higher returns at
than other assets at the same risk-weightings, and for
“investment-grade” products – but where the sellers perversely
arranged/paid for the rating, instead of buyers. This nonsense is still
continuing; even as the FDIC is closing banks right and left, banks
about to fail can attract “brokered deposits” from investors chasing
higher interest rates than are available at the safer banks (as
deposits remain guaranteed), as management gambles for returns that
will keep them in office.

The unregulated buyers of CMOs and CDS should of course be left to
suffer the consequences of their own investments; the Fed`s
intervention in support of LTCM (and the investments by insured banks
and investment banks) simply contributed to the “too big to fail”
massive risk shifting that has come home to roost.

Federal regulators should be reconsidering their fundamental
preconceptions, and moving away from trying to micro-manage risks in a
futile whack-a-mole enterprise, toward one that places more
responsibility for risk analysis on depositors and investors.
Otherwise, we will see simply empty promises, and more risk shifted to

We`ll be better off if everyone has more of their own skin in the game.


Rot at the Core: Dan Ariely on financial crisis & psycho-social aspects of cheating

April 3rd, 2009 2 comments

I just ran across an interesting speech and related commentary provided last month at TED by behavioral economist Dan Ariely, professor at MIT and author of Predictably Irrational.  Both the speech and the commentary are worth a look.

Ariely’s speech, billed as “Why we think it’s OK to cheat and steal (sometimes),” discusses how we fail to test our often-wrong intuitions, and focusses on the cognitive and social aspects of cheating behavior.  The Carnegie Council (which has a sidebar with other resources on cheating and corruption) summarizes Ariely’s speech as follows:

Ariely finds that in most situations a lot of people cheat a little, and that there are predictable ways to influence honesty.  When test subjects are reminded of morality, cheating drops. When subjects are distanced from the object of reward—for example, by replacing money with redeemable tokens—cheating increases. When other members of your social group cheat, you are more likely to cheat as well.

TED also asked Ariely for his thoughts on the Bernie Madoff scandal; these are a short read (about a page), but allow me to present a “readers’ digest” here:

Madoff’s massive Ponzi scheme was horrific on many levels. But while we watch the next phase of the scandal, it’s important to ask: What lessons are we going to learn from this? I can see three lessons that relate to my work studying human irrationality — and in particular, some non-useful lessons we might [unintentionally] learn.

One lesson that individuals and foundations are likely to take from the Madoff scandal is that in addition to diversifying their portfolio across several investments (stock, bonds, equity, cash), they also need to diversify their investments among several advisors. … You will need a whole new level of coordination among them so they can have the right amount of cash, bonds, stocks etc., across all of your assets.

And I think that people will begin to over-diversify across investors. Why? Because when we have one large and salient instance in our minds, it can be so powerful that we overemphasize it. …  In general, what we find when there’s one single vivid event is that people overweight it — we focus on it too much. So that’s the first lesson: We’re going to learn from the Madoff scandal, but we are going to overdo it.

Another non-useful lesson that I think we will adopt is to start searching with more vigor for other bad apples. On one hand, it is clearly important to prevent more Madoffs, but at the same time I worry that as a consequence of searching for bad apples, we won’t pay enough attention to other financial behavior that might not be as badly wrong but that can actually have larger financial consequences.

In our research on dishonesty, we found that when we give people the opportunity to cheat, many of them cheat by a little bit, while very few cheat by a lot. In our experiments, we lost about $100 to the few people who cheated a lot — but lost thousands of dollars to the many people who each cheated by a bit. I suspect that this is a good reflection of cheating in the stock market, where the real financial cost of the egregious cheating by Madoff is actually a tiny fraction of all the “small” cheating carried out by “good” bankers.

The risk here is that if we pay too much attention to chasing bad apples, we might pay too little attention to the situations where the small dishonesties of many people can have large consequences (such as paying slightly higher salaries to cronies, making small changes to financial reports, doctoring documents, being slightly dishonest about mortgage terms), and in the process neglect the real economic source of the trouble we are in. (emphasis added)

A third bad lesson that I think people will take from this concerns the way we define acceptable levels of cheating. In a study that may parallel Madoff’s egregious dishonesty, we … [found] that when someone who is part of our own social group cheats, we find it more acceptable to cheat, but when people who are not part of our social group cheat, we want to distance ourselves from these people and cheat less. (emphasis added)

Madoff was part of the financial elite — part of an in-group of our financial leaders. Think of all these people who were in his house, who knew him well. So now, when other people in this circle see him cheating, think about the long-term consequences: Would these other people in this financial industry now be more likely to take the immoral path? It doesn’t have to be another Ponzi scheme. It just means that, now that they have been exposed to this extreme level of dishonesty, they might adopt slightly lower moral scruples.  … I don’t think that those in his circle will necessarily become more Madoff-like people, but I do suspect that they will get a substantial relief from their moral shackles. Sadly, that’s his legacy.

So, Chapter One of the Madoff scandal is over, but I worry that the negative downstream consequences of this experience are just starting …

I share Ariely’s concern that we are likely to be distracted by a focus on big “bad apples” that may satisfy our needs to string someone up, but that will ignore the rot at the core – the systemic cheating that, in the American system, is very much related to the institution of state-granted “limited liability” to corporate investors/shareholders.  This grant (1) frees investors from the downsides of losses suffered and borne by third parties as a result of corporate actions, (2) limits investor incentives – and abilities – to monitor and control risks faced by and generated by executives, managers and other employees, (3) thus incentivizing risky behavior and providing greater freedom of action to executives and managers – including freedom of action to seek favors from government , (4) leaving executives and managers freer to loot their companies by taking large bonuses, which shifting downside risks to shareholders and taxpayers, and (5) fuelling pressures by consumers and others adversely affected by corporations to seek to use legislative, regulatory and judicial mechanisms to check corporate behavior.  In sum, limited investor liability has proven to lie at the core of the moral hazards which have produced the Great American Ponzi scheme that our fearless leaders are now struggling mightily to patch together and profit from.

Did I leave anything out?  (Ah, maybe how various firms, investors and their political handlers profit while socializing climate change risks?)

Anyone game for exploring ways to reduce the destructive gaming and rampant cheating in the American system?

Rot at the core: federally-owned TVA’s massive coal flyash spill – the TVA "protects" affected residents by hassling/arresting the volunteers who help them

March 10th, 2009 No comments

A few items of interest have come to my attention regarding the TVA’s massive spill last December 22 of wet coal fly-ash into a lovely river area near Kingston, TN (about 35 miles west of Knoxville, at the junction of the Emory and Clinch Rivers).  The collapse of a retaining wall released over five million cubic feet (more than a billion gallons) of wet coal ash
flooded nearly 400 acres of land adjacent to the power plant and into the nearby
Clinch and Emory rivers, filling large areas of the rivers, damaging homes and property, rupturing
a major gas line and damaging a
railway line.

– according to a report in the Tennessean, the TVA was long aware of the possibility of a release from the Kingston site, but elected not to proceed with any costly fix – the most expensive fix apparently in the ballpark of $25 million – because it didn’t want to set a precedent for spending similar sums at its other wet ash storage sites.  Penny wise, pound foolish – how often that happens when decision-makers don’t face personal responsibility for the downsides (yes, my “limited liaibility breeds moral hazards” meme)!

– in response to the accident, the EPA announced on Monday that it will: request electric utilities
nationwide to provide coal ash impoundment information (the EPA estimates there may be as many as 300 coal ash impoundments across the US
); conduct on-site assessments to determine structural
integrity and vulnerabilities; order cleanup and repairs where needed; and develop new regulations for future safety.  Said administrator Lisa Jackson: “Environmental disasters like the one last December in Kingston should never happen anywhere in this country.”  Not only are such regulations too little too late and probably unneccesarily costly, but one wonders why in this case she fails to note that as the TVA is wholly-owned by the US government, in this case the government did this to us itself.  The industry must be really grateful to TVA for leading the way to more regulations!

– The TVA is spending $1 million a day on the cleanup, and estimates final recovery may cost $525 million to $825 million.  This is just the cost for recovering the spilled ash, which could take two years or more, and does not cover long-term mediation costs, or litigation expenses, fines or any settlements
from the accident or the extra cost of upgrading coal ash ponds at
other TVA plants
, or costs being borne by local, state or other federal agencies.  So we could be easily talking physical damage of a billion dollars or more, and decades before local homeowners can start enjoying the rivers again.

– The TVA announced in February that TVA it lost $305 million in the fiscal quarter
ending Dec. 31 2008 due to the $525 million charge
the utility took for the
estimated cost of the ash spill.

– In response, TVA president and CEO Tom Kilgore, who earned $2.2 million in FY2008, saw his base and incentive compensation for FY 2009 cut by about half.  Said Kilgore, who had outraged ratepayers in October (on the heels of rate increases) by taking large compensation increase for FY2009 (in a package worth up to $3.275 million), “I’m at the point in
my career where it’s not all about money.”

– The fly ash poses health risks, both as the small particle dust can affect the lungs and since the ash contains elevated levels of heavy metals that were left behind from the combusted coal.  A Tennessee Department of Health survey indicates that a third of the people living near the toxic coal ash spill are experiencing respiratory problems, and about half
have increased stress and anxiety.  

According to TVA President Tom Kilgore, TVA and the state Department of Environment and Conservation have tested the water and believe there’s “no reason to believe that the water is not safe,” but “water quality tests conducted by environmental activists showed arsenic
levels as high as 48 times the primary drinking water standard in river
water nearest the spill
. Coal industry watchdog United Mountain Defense
and Washington, D.C.-based Environmental Integrity Project said January
levels of arsenic, lead, selenium, cadmium, beryllium, antimony and
copper violated water quality standards and exceeded primary drinking
water standards.”

State senator Tim Burchett (a Republican) characterized TVA officials as “arrogant clowns” on March 10 as he presented legislation on coal ash storage to a Senate committee.  “I want to assure my colleagues that any offense (to TVA) is intentional,” he said. “I have little faith in what TVA is telling us.”

More on water testing results and on health, safety and environment impacts is here.

– the TVA is naturally trying to buy out residents, both to cut future losses and to limit coverage of the affected area. Apparently these buyouts require the sellers to waive all future health claims against the TVA.

– On top of such purchases, though, TVA – through its own police department – is trying to make it difficult for residents to remain and to prevent full disclosure of health risks, by restricting access to public roads and to the homes of residents, requiring any who receive medical checkups from TVA doctors to waive health claims and by hassling volunteers who, at the invitation of residents, do ash, water and air testing, deliver bottled water, and assist some residents with the transportation needs.   In two recent incidents, the TVA police have gone onto private property to detain volunteers and force the removal of private air quality monitoring devices, and arrested, shackled and jailed on March 6 a driver who had used a public road – now restricted by the TVA – to drop off a two grandmothers (one elderly and vision-impaired) at their homes after a town meeting – and who had written permission from residents to visit at any time.

According to one group, volunteers “have relatives in the Swan Pond Community and have an
open invitation to visit residents or their property near the disaster
site at any time day or night.”   The volunteer who was arrested reports the following, entirely believable – conversation with a TVA officer when he was being booked:

So as I was escorted to the Roane County Jail for processing I was informed by the TVA officer that he was “protecting the residents” of the Swan Pond Community from “people like me.”  When I questioned him further about this he stated that he meant onlookers and sight seers and people taking video while disrupting vehicle traffic and impeding the cleanup of the disaster site.
Well if TVA has any video proof of me personally disrupting vehicle traffic or impeding the cleanup of the disaster site I would like to see it, please post it to YouTube; show the world exactly what I am doing, PLEASE.    When I stated,” why would the residents need to be protected from someone who is delivering water, taking people to the grocery store, hospital, doctor, not trespassing, monitoring air/ water/ coal ash, helping facilitate trainings and organize with the local community, and sit at the Harriman American Legion building for more than 20 hours helping with heavy metal exposure testing,” he could not answer.

So far, one lawsuit against the TVA has been filed in federal court in Knoxville on
behalf of 109 citizens.  The TVA harassment policy may be aimed in part at preventing residents from gathering independent evidence to support their claims.

The TVA is governed by a nine-member board of directors, all current members of which were appointed by nominated by former President Bush (on
the approval of senators from the region) and confirmed by the Senate. 
Over the objections of the current chairman and two others
(Republicans),former national GOP committee chairman and former TVA board member was reappointed in February as chairman.  Since the TVA board has two vacancies, will
have two members terms expire in May and another in 2010, President Obama will have the opportunity to take control of the board.

– Photographic and video images of the impact of the ash spill are here:

– by renowned photographer Carlan Tapp

– by local residents (first three minutes are home footage before the accident)

– More information by the enviro group doing testing and resident support work

– the TVA’s home page, etc.


Where is anyone calling for the privatization of the TVA?

Categories: Coal, damage, limited liability, moral hazard, TVA Tags:

Rot at the Core: KC Fed Pres. Hoenig says "Too Big has Failed", and calls for receivership of failed banks / end to bailouts

March 9th, 2009 No comments

Finally, someone in the Fed is arguing that the Fed should stop printing money like crazy to bail out managers, owners and counterparties of failed banks.

In a speech on Friday, March 6, Thomas Hoenig, President of the Kansas City Fed, argued strongly that “Too Big has Failed“, and that the continuing ad hoc bailouts are just stringing out the ultimately necessary realization and workouts of failed banks and bad assets, thus creating uncertainty while increasing the cost of the crisis by prolonging the unavailability of credit.  Hoenig argues that a transparent receivership program should be set up for large, insolvent institutions, whose management should be fired and shareholders wiped out.  The whole speech is worth a read.

It is bracing to see someone in the Fed finally start talking about action to end the bailouts, but an honest observer would have to realize that federal and state regulators already have all the authority the need to take over insolvent banks; they just need to have the Fed and Geithner stop handing out money to those who have already lost hundreds of billions.  In rougher terms, no more “stinking badges” are needed; just action.  It is unlikely that simply the creation of a new RTC for too-big-to-fail banks will, as Hoenig suggests, by itself “restore an important element of market discipline …, limit moral hazard concerns and restore  and restore … fairness of treatment”.   Federal and state banking regulators already have sufficient authority; what they`re lacking is the political will to stand up to the managers and owners of failed institutions and pull the trigger.  Hoenig is essentially punting to our lazy and corrupt Congresscritters, who will no doubt give owners and managers a chance to influence any new receivership law.

Hoenig does indicate that lawmakers/regulators should consider how to prevent firms in the future form backing “to big to fail”; my suggestion?  Follow the suggestion of Glassman and Nolan that banks be encouraged to adopt a partnerhip or corporate structure that does not include a limited liability feature for owners, who, because they would have unlimited personal liability for losses, would  be incentivized to very closely monitor risks.

h/t to Calculated RISK  

Categories: banks, Fed, limited liaiblity, moral hazard Tags: