The Committee of Public Safety

How do you fight a Black Swan? Since all Black Swan ex post explanation is invalid (or it wouldn’t be a Black Swan), the best you can hope for is to look at prior Black Swans and steal the moral of their story.

The New Deal as a economic recovery plan was anemic at best; the Great Depression was much worse and much deeper in the US than in the other industrialized nations of the time like Great Britain or France. However, it has a heroic narrative. The key to the moral I draw from the New Deal story is found in the memories of my grandparents. At one time I was struck by the gap between macroeconomic reality and their fond memories of FDR. Then I realized the core of FDR’s genius: he was a great entertainer and the New Deal was a Hollywood spectacle of the grandest kind; even if it did nothing, at least it showed positive action.

Hoover was immobility personified. Who would you rather spend the next four years with? This guy:

Gloom and Doom

Or this guy:

Happy Days are Ah Ah Ah

When FDR was later asked if he wanted to employ Hoover during WWII, he remarked that he wasn’t the Lord and he couldn’t raise “Herbie” from the dead.

Both of my grandfathers were in the CCC. Even my grandmother, a staunch Republican till her dying day, looked up to FDR. Their devotion reveals the winning formula:

1. Keep the people entertained.

A few story lines:

1. Give folks money and make them work. This has two goals: it puts money in people’s pocket and keeps them occupied so they aren’t plotting to create a socialist worker’s paradise.
2. Bring back the draft or impose a universal service requirement for ages 18-25. This is the segment of the population that provides the foot soldiers of the revolution.
3. Give everyone $10,000 as their baseline income and index it for inflation. If income falls below $10,000, make up the difference for everyone.
4. Regulate all money management vehicles. Bring hedge funds under full disclosure. Leave no part of the financial system invisible. The core essence of a free market system is ensuring that necessary information is known and circulating, an extension of the basic rationale for free speech.
   

   Voltaire: "in this country, it is wise to kill an admiral from time to time to encourage the others"

5. Hammer a few plutocrats. Every economic downturn needs an Admiral Byng. Differentiate between the productive rich and “speculators”. Since shooting a few plutocrats as examples to the rest is ruled out by due process under normal conditions, throwing a few into the general prison population is the second best thing.
6. Means test everything. Medicare and Social Security should not go to the wealthy. They should be distributed on the basis of need alone.
7. Require that FICA be paid on all wages. Everyone should pay into Social Security just in case they trip and fall.
8. Establish a forced savings program. Put the results in the Federal Thrift Savings Plan.
9. Withdraw forces from Afghanistan and Iraq. Invade Venezuela. Iraq has served its purpose. We have re-injected counter-insurgency into the Pentagon. The fruits of victory in Iraq will be realized in the ghettos of Los Angeles. And, if you need oil, might as well get it closer to home and boot Senior Crazy Guy too. Venezuelans are pushovers.
10. Go to a flat tax. It makes it easier to crush plutocrats if they have fewer holes to hide in. See the Russian experience for how effective a flat tax is when combined with KGB classic tactics.
11. Cut the corporate tax rate but restructure it so that it encourages redistribution through dividends.
12. Strengthen corporate governance by strengthening shareholders in publicly traded companies. A radical proposal would have a corporation return all money to the shareholders on a per annum basis and only get it back as reinvestment if management performed well.
13. Selectively nationalize percentages of companies and put them into a sovereign wealth fund which, in turn, goes into the Federal Thrift Savings Plan to fund American savings. This is happening now. See AIG.
14. Retool for Unrestricted Warfare. Reform the defense community so that we can manipulate or overthrow foreign governments on the cheap.
15. Restrict our sphere of influence to the Western Hemisphere and the Western European and East Asian littorals. Write off Central Asia and let China and Russia fight over it.
16. Do the Pickens Plan. If anything, it’s good make work.
17. Kick out illegal immigrants. In the face of a massive macroeconomic contraction, let’s see which jobs American’s won’t take.
18. Nationalize unions. Declare yourself a worker’s republic. In a worker’s republic, there’s no need for unions. That’s what the Chinese have taught us.
19. Abolish tenure. Let philosophy faculties earn there keep in the streets, like Diogenes.
20. If you can’t be part of the solution, be part of the problem. Be pro-something and anti-nothing. Create programs until all letters of the alphabet are exhausted.
21. Spend money on visible infrastructure. Monuments convey a sense of purpose.
22. Hire a good leading man. This point favors this guy…
    

    I'm too hip for this too hip poster.

    …over this guy:

    

    Yarrr! I hate kittens and puppies, especially the cute ones.

    Better yet, elect this guy:

    

    Mr. President

    Or Russia’s Batman, Vladimir Ilych Pooty Poot:

    

    Pooty Poot

Buffet has spoken. Most of his commentary is pablum for Wall Street types, the blind day walkers who believe in a hypothesis based on the pretense that asset markets are omniscient. Buffet’s secret of success was to take his mentor’s concept of a margin of safety and mix it with an age old path to seeking wealth: rent seeking.

A free market is always a subset of a broader political market, the bazaar of power. The distribution of goods always follows the distribution of power. The distribution of power always follows the means of coercion: what mechanisms of violence and threat are available and what resources are needed to support their use.The organization of society is determined by how society has to organize for violence.

The road to wealth followed the same road as the road to power throughout most of history. Noblemen and the odd noblewoman fought over grants of income from a paramount leadership, often seeking monopolies. This is the essence of rent seeking: getting wealth through manipulation of the market in power rather than the market in wealth (inasmuch as they can be separated).

Buffet seeks to acquire rents, preferably rents with monopolies, by taking advantage of market fluctuations to buy them with a market of safety. These investments are bought (relatively) cheap and provide Buffet with streams of capital which, while not always as high as other businesses, allow him enough room to maneuver that he can pick up other bargain rents when others can’t.

Berkshire Hathaway sits atop a massive pile of dry powder for days like this. Buffet learned early that insurance companies have floats that can be deployed at opportune times to invest. If you are conservative in underwriting, then little money is payed out in claims and people are essentially giving you free money. The core of Berkshire is its insurance businesses like GEICO. It also seeks out local monopolies like RC Willey that have existing investments in showrooms and distribution networks that are not easily duplicated. He also seeks out monopolies like PacifiCorp that have legal quirks that make them hard to put out of business. Barring catastrophic civilization level or massive decentralization of power generation, people will always need power. Berkshire was looking at two units of AIG but the government was making a better offer.

Berkshire at its purest is a collection of sinecures, an old and reliable form of profit. Given old school wiles, Berkshire may survive the deluge.

One problem with this modern age is the loss of the higher forms of vitriol. Properly done, you destroy from the inside out, gnawing away at the soul by gradually eroding it, increasing its sterility and aridity, until it lightly falls in like a collapsing ash heap and blows away, the literal quintessence of dust. If you are going to launch a campaign of character assassination, do it with verve and style. Mix in amateur psychoanalysis, references to obscure European authors, and bows to pop culture. Target those they love, make their strongest supports into cracks in their foundation. Embiggen the trivial quirk into a Shakespearean tragic flaw, leading inevitably to doom. Stir until the juices are cooked in.

One small flicker of the high form amidst the appalling lack of artistry in contemporary negative rhetoric. I’m reminded of a toast from C.S. Lewis’s The Screwtape Letters:

Your dreaded Principal has included in a speech full of points something like an apology for the banquet which he has set before us. Well, gentledevils, no one blames him. But it would be in vain to deny that the human souls on whose anguish we have been feasting tonight were of pretty poor quality. Not all the most skillful cookery of our tormentors could make them better than insipid.

Oh, to get one’s teeth again into a Farinata, a Henry VIII, or even a Hitler! There was real crackling there; something to crunch; a rage, an egotism, a cruelty only just less robust than our own. It put up a delicious resistance to being devoured. It warmed your inwards when you’d got it down.

Instead of this, what have we had tonight? There was a municipal authority with Graft sauce. But personally I could not detect in him the flavour of a really passionate and brutal avarice such as delighted one in the great tycoons of the last century. Was he not unmistakably a Little Man — a creature of the petty rake-off pocketed with a petty joke in private and denied with the stalest platitudes in his public utterances — a grubby little nonentity who had drifted into corruption, only just realizing that he was corrupt, and chiefly because everyone else did it? Then there was the lukewarm Casserole of Adulterers. Could you find in it any trace of a fully inflamed, defiant, rebellious, insatiable lust? I couldn’t. They all tasted to me like undersexed morons who had blundered or trickled into the wrong beds in automatic response to sexy advertisements, or to make themselves feel modern and emancipated, or to reassure themselves about their virility or their “normalcy,” or even because they had nothing else to do. Frankly, to me who have tasted Messalina and Cassanova, they were nauseating. The Trade Unionist stuffed with sedition was perhaps a shade better. He had done some real harm. He had, not quite unknowingly, worked for bloodshed, famine, and the extinction of liberty. Yes, in a way. But what a way! He thought of those ultimate objectives so little. Toeing the party line, self-importance, and above all mere routine, were what really dominated his life.

We are a race of Milquetoasts.

Barack Obama made an interesting aside on TV this evening. He pointed out that Mahmud Ahmadinejad, the infamous president of Iran, is not the most powerful man in Iran.

Ahmadinejad is the Paris Hilton of Iran. All flash, no substance. Ayatollah Ali Khamenei is Supreme Leader of Iran; Ahmadinejad is his performing monkey. Khamenei is Dean Martin; Ahmadinejad is Jerry Lewis. Ahmadinejad can go out and say truly crazy things and Khamenei comes off as rational because he says slightly less crazy things.

This is a useful insight from the senator from Illinois. As pointed out by NYU professor of political science Bruce Bueno de Mesquita in a podcast last month, most foreign heads of state, when given the chance to meed with a senior Iranian leader, get to meet Ahmadinejad. They get to play with the monkey. Vladimir Vladimirovich Putin, Russia’s Batman, got to meet Khamenei.

Bueno de Mesquita is interesting. His most noted professional achievement to date is successfully predicting that Khamenei would become Supreme Leader after Khomenei and Akbar Rafsanjani would become president of Iran, This was in 1984, five years before Khomenei died. In a recent study he predicts that 1) Iran will develop the capacity to go nuclear and 2) the US won’t bomb while Bush is still in office.

Most of Bueno de Mesquita’s predictions derive from a proprietary model drawing from public choice theory and game theory among others. One aspect of this is the theory of the selectorate:

The theory operates on two fundamental groups, the Winning Coalition and the Selectorate, both drawn from the overall populace of a state. The Winning Coalition is a subset of the Selectorate, and the Selectorate is a subset of the overall population. The Selectorate is simply those within the state that have a say in policy outcome. The Winning Coalition is a portion of the Selectorate sufficient to choose and sustain a leader in office.

The core operation of a political system is the allocation of goods:

A public good is such a good that everyone non-exclusively enjoys. A private good is a good that is enjoyed exclusively by a select few and cannot be shared. Everyone in the Selectorate (including the Winning Coalition) reap the benefits of public goods while only those within the Winning Coalition enjoy private goods.

Allocation is the central determinant of political survival:

A leader has the greatest chance of political survival when the Selectorate is large and the Winning Coalition (autocracy) is small because members of a winning coalition can easily be replaced by other members of the selectorate who are not in the Winning Coalition. The cost of defection for members of a Winning Coalition can be potentially large—namely the loss of all private goods. Similarly, the chances of a challenger replacing a leader are low in an autocratic system because the chances of members of the Winning Coalition defecting to him would be low. More private goods are allocated in this system compared to public goods than any other system.

In a monarchy, where the Selectorate is small and the Winning Coalition is even smaller, the challenger has a greater opportunity to overthrow the current leader. This is because most members of the Selectorate are also in the Winning Coalition. Usuaally, if a new leader comes to power, chances are that any given member of the Winning Coalition will remain in the Winning Coalition. The incentives to defect in order to get more private goods from a challenger are not, in this case, outweighed by the risk of not being included in the new Winning Coalition. The proportion of private goods to public goods is closer than in an autocracy.

A scenario where both the Winning Coalition is large and the Selectorate is even larger provides the least amount of stability to a leader’s hold on power (democracy). Here, the number of public goods outweigh the number of private goods simply because of the sheer size of the Winning Coalition; it would be far too costly to provide private goods to every individual member of the Winning Coalition when the benefits of public goods will be enjoyed by all. Because the leader can’t convince Winning Coalition members to remain loyal through private goods because of the cost, a challenger poses a greater threat to the incumbent than in any other governmental system.

Senator Obama may be aware of these ideas. He is, for example, aware of libertarian paternalism since he was a collegue of one of the theory’s creators at the University of Chicago law school. The Bush adminstration is aware of them: Condoleezza Rice is a colleague of Mesquita. It would be interesting to know if it’s had an influence on Iran policy.

[Goo is] like water; for water in its natural course runs away from high places and hastens downwards.

So [with goo], the way is to avoid what is strong and to strike at what is weak.

Water shapes its course according to the nature of the ground over which it flows; [goo] works out [its] victory in relation to the foe whom [it] is facing.

Therefore, just as water retains no constant shape, so in [goo] there are no constant conditions.

- Sun Tzu, The Art of [Goo]

Goo is reactive. Adaptation happens after a problem reveals its hand. Goo is organic, emergent, and flexible.

Preemptive systems trend towards the Platonic and Newtonian, a mechanistic, clockwork universe populated with ideal forms. This is natural, since the Platonic and Newtonian, with their clean, rounded-off edges, fit better in the head. The brain can’t swallow the size and wildness of the universe. So it must scrunch the universe down to size, which means information, some of it important, will be lost. This creates gaps in understanding the world where Black Swans sneak in.

By definition, a Black Swan is an event so unlikely that it cannot be anticipated:

Nassim Nicholas Taleb’s book The Black Swan is about “unknown unknowns”. A ‘black swan’ is a rare, large-impact, hard-to-predict and discontinuous event beyond the realm of normal expectations. Before black swans were discovered in Australia, people believed all swans were white—an incontrovertible view confirmed by available empirical evidence. “The sighting of the first black swan,” wrote Taleb, “…illustrates a severe limitation to our learning from observations or experience and the fragility of our knowledge.” The discovery of a single black bird invalidates millennia of confirmatory sightings of only white swans.

Black swans have three traits. First, it is an outlier: it lies outside the realm of regular expectations, because nothing in the past points to its possibility. Second, its impact is extreme. Third, in spite of being an outlier, human nature makes us concoct explanations for its occurrence after the fact to render it explainable and predictable.

Taleb argues that black swans account for almost everything in our world, from the success of ideas to the dynamics of historical events and our own personal lives. He further asserts that the impact of black swans has been accelerating since the Industrial Revolution.

Black Swans lead to wicked problems. The characteristics of a wicked problem is:

1. There is no definitive way to formulate an wicked problem.
2. We cannot understand an wicked problem without proposing a solution.
3. Every wicked problem is essentially unique and novel.
4. Wicked problems have no fixed set of potential solutions.
5. Solutions to wicked problems are better-or-worse, not right-or-wrong.
6. Wicked problems are interactively complex.
7. Every solution to an wicked problem is a ‘one-shot operation.’ Because there is no opportunity to learn by trial-and-error, every attempt counts significantly.
8. There is no immediate and no ultimate test of a solution to a wicked problem.
9. Wicked problems have no ‘stopping rule’.
10. Every wicked problem is a symptom of another problem.
11. The problem-solver has no right to be wrong (planners are liable for the consequences of the actions they generate).

Since it’s likely that Black Swans like the adventures of Gavrilo Princip and Pet Rocks will continue to afflict the best laid plans of mice and men, how do you handle them? Do you anticipate them through planning, a sort of universal Bush Doctrine of preemption, or do you become goo?

William McChesney Martin, Jr., the longest-serving Fed chair, once said that the job of the Federal Reserve is to “to take away the punch bowl just as the party gets going”. In the wake of the current crisis, questions have been raised about whether the punch bowl should have been taken taken away earlier from Wall Street. Some financial commentators favor preempting asset bubbles. Some advocate letting mass delusions run their course and just cleaning up afterwards.

In a broader context, I’m not sure which approach I tilt towards. Proactive planning sounds good in theory. Capturing requirements before starting an undertaking, following this line of reasoning, would anticipate most issues, nail down details, and allow a reasonable definition what needs to happen when. This makes life more predictable and reduces fear of the unknown future.

In software development, the thorough application of proactive planning is associated with the waterfall model. Requirements are gathered, a design is defined based on the requirements, the design is implemented, the implementation is tested, the testing is verified, and then the software goes into maintenance. However, most software projects fail. Waterfall, the model used at the inception of the computer age, has been jettisoned and derided for twenty years now. Yet some, particularly in government contracting, continue to practice it with indifferent success.

It may be because software engineering is a new discipline. Construction, for example, has been around for millennia. For example, an experienced construction project manager was able to use modern tools to plausibly recreate the construction schedule of the Great Pyramid. At that point, the engineers of the Old Kingdom may have been at the same point in the evolution of construction as we are in the evolution of software engineering.

There may be problems with intensive planning beforehand. The planning fallacy is the innate cognitive bias all mankind has to under-estimate how long it will take them to finish a task. If Nicholas Nassim Taleb is correct, you’re screwed if you leave the country of Mediocrestan and enter the country of Extremistan. Mediocrestan is the realm of the easily predictable, governed by the Bell curve. This is the environment Man is optimized for: you see a leopard, you turn, and you run. Risks are pretty easily ascertained. Extremistan is the opposite, characterized by the 80/20 rule. Extremistan is characterized by Black Swans, events that cannot be predicted and, when they occur, change everything. People may predict easily forseeable events in planning, people may get lucky and predict something by accident, but, when faced with the Black Swan, as Taleb asserts, the only thing they can do is create plausible explanations after the fact.

The alternative is being reactive. More later.

Monkeys are stupid. To rule monkeys, you need little more than food and entertainment. Panem et circenses.

Take Wall Street. A free market is mass monkey chatter. Short-term entertainment, represented by the DJIA, dominates any passing monkey awareness of financial markets. Monkey brains, optimized for narrative-based associative storage, are unable to actually comprehend the jungle of information contained in mass monkey talk. Monkey brains, however, can understand the limbic, primal nature of pleasure and pain. Bears and bulls provide a convenient compression algorithm for shoe-horning short term market noise into tiny monkey brains.

The bailout being contemplated by the Alpha Monkeys may be sufficiently dramatic enough to keep market participants entertained enough to prevent a liquidity crisis. However, there are severe unknowns in today’s market. No one has ever tested the theory of mass securitization during a systemic level panic. Whether risk is distributed enough to prevent cascading market failure may be a dubious proposition. The failure of the sub-prime market to spread risk around is not a promising precedent. In some respects, it seems as if securitization concentrated risks instead of distributing them. It may be possible to create a domino with airbags but in the end it’s still a domino and dominoes, when pushed, fall over. What happens when we start hitting the more abstract derivatives? Warren Buffet has been worried about derivatives for years, calling them “financial weapons of mass destruction”; when Berkshire Hathaway bought reinsurer General Re, one of the first things they did was unwind General Re’s derivatives business. Now we get to watch for the mushroom cloud.

A bailout may keep Wall Street entertained but, as Benjamin Graham pointed out, in the short term, the stock market behaves like a voting machine, but in the long term it acts like a weighing machine. A bailout as theater may be sufficient if economic fundamentals are sound. Many of the great financial entertainers from Alexander Hamilton organizing the first bailout at the dawn of the Republic to J.P. Morgan acting as a de facto proto-Fed, have mitigated the effects of liquidity crises through great financial theater. The depths of the Great Depression, on the other hand, may have been brought on by Herbert Hoover’s bad stage presence. However, as we approach the end of the post-World War II macro-bubble, even if Ben Bernake and Hank Paulson were great actors (and they aren’t) there may be no entertaining ourselves out of this hole.

If the narrative fallacy posited by Nassim Nicholas Taleb is true, monkeys may not have the brain capacity to absorb all of this. The human mind may not penetrate the fourth quadrant. The only comfort that the narrative fallacy provides is that monkeys should be able to come up with a comforting moral fable afterwards. History, as Nabulione Buonaparte remarked, is a fable agreed upon. As the sky falls in, maybe the fables we concoct will be of some comfort.

That will keep the monkeys in line.