The Committee of Public Safety

Budgies is cute

One powerful driver of human history is abstraction. Things are easier to contemplate when what is being contemplated is either:

• Someone else’s problem

or

• A fictional someone else’s problem.

The real world, as Nicholas Nassim Taleb points out, is too complex to fit in the tiny space between two ears. It has to be compressed and that means information, hopefully noise and unnecessary clutter, must be removed as reality is re-sized for our little brains. One of the most powerful compression algorithms is availability heuristic [per Wikipedia]:

Essentially the availability heuristic operates on the notion that “if you can think of it, it must be important.” Media coverage can help fuel a person’s example bias with widespread and extensive coverage of unusual events, such as airline accidents, and less coverage of more routine, less sensational events, such as car accidents. For example, when asked to rate the probability of a variety of causes of death, people tend to rate more “newsworthy” events as more likely because they can more readily recall an example from memory. In fact, people often rate the chance of death by plane crash higher than the chance by car crash, and death by natural disaster as probable only because these unusual events are more often reported than more common causes of death. In actuality, death from car accidents is much more common than airline accidents.

The mind favors vividness over regularity. The availability heuristic is able to reduce experience into rich vivid colors that are easy to store and easy to recall. If things are a dull, uniform grey, the mind throws them away since nothing can be (or needs to be) highlighted. Habit is the ruler of all mankind and vivid habit is the most powerful ruler of all.

Abstraction seeks to dull personally experienced vividness. The human mind is drawn to vividness yet it flees from it all the same. Vividness is often associated with personal pain and that’s the vividness folks are keen to avoid. Abstraction seeks to reduce the level of emotional investment derived from personal experience and replace it with the (possibly) vivid experience of someone else:

Fools say that they learn by experience. I prefer to profit by others experience

- Otto von Bismarck

With abstraction, you can gain vividness by completely fictional experience, all black and white with no gray hues to overheat the compression process. Or you can counter the availability heuristic by reducing every abstraction to gray, hiding anything you like in a sea of flatness, a sort of security through obscurity. Either approach has its uses.

There can be only one Lord of the Rats

Modern man is anesthetized. The course of developments since the onset of the Financial Revolution in the Netherlands in the early seventeenth century has been to further remove more and more of the population from How Things Are Done through abstraction. Stocks, bonds, and corporations insulated many people from personal responsibility for financial losses and the risks of investment. Meat packing plants insulated the population from the intimate familiarity with slaughter that came from butchering their own food. Hiring mercenaries insulated most of the people from the reality of having to kill for the achievement of their political endeavors. Factories distance us from the realities of producing goods. Division of labor equals distraction of labor.

In recent years, especially in contemporary America, abstraction has grown more extreme. This abstraction is especially pronounced in finance. Securitization has separated the lender from the risk of lending. No pain is associated with lending poorly. The lender takes the money and runs. Loss is left to the poor sucker that buys the security from the originator.

Abstraction is even worse with some derivatives. Futures based on commodities have some tangible presence in the world. You can always take delivery on the commodity. Some derivatives have no reality, like VIX. If you want to take delivery of volatility, you’re out of luck (”Hey baby, I have some volatility in my pocket. Do you want to see it?”). These end up being bets on nothing and are essentially gambling. These abstractions are useless vehicles for separating the credulous from their dollar (when there are far more productive ways of doing that). They’re better off in Vegas.

Pain needs to be brought back into financial instruments. The reason why was demonstrated by B.F. Skinner:

Skinner's box

The rat is in the cage. The green light comes on. The rat hits the response lever and gets a food pellet. The red light comes on. The rat hits the response lever and gets shocked by the electrical grid. After a while, the rat will hit the response lever and eat when the green light comes on. It will not hit the lever if the red light comes on, even after the electrical grid is turned off. The rat has been conditioned.

Financiers should be conditioned in the same way. They must feel the electric shock if they feed under a red light. They must invest their own fortunes in every transaction they make and lose if they blow it. They must feel the pain of failure. Risk must be risk to them, not something hidden behind a model that poorly captures reality. They must have the vividness that only comes by eschewing abstraction and embracing personal experience, with all the pain that can entail. I would suggest that they be wired for electroshock with every security they sell but I’m still working out the engineering details for that one.

The advantage that a free market purports to have over other systems of power distribution is that signals such as prices are free to reach the people that need them and people are incentivized to be open to those signals. When a market is out of sync with that fundamental function, it has ceased to function and its legitimacy will be under siege. Finance is too insulated from the messages of the free market system. They’ve foisted the risk off on to depersonalized groups: secondary buyers, shareholders, and tax payers. As has been said elsewhere, profits are privatized, losses are socialized. This is an unsustainable system. The answer is that profits and losses have to be personalized. Then market signals will be received and felt. Car crashes will still be a greater risk but they will be perceived as airplane crashes. However imperfect, this is the best system we can hope for. To paraphrase Winston Churchill, a free market is the worst form of power distribution, except for all the others.

Financier raised correctly