Rational Markets and Corruption

When a religious fundamentalist suffers a “crisis of faith” it is a mournful incident to witness. Such was the occasion when Alan Greenspan, former Chairman of the Federal Reserve appeared before Congress in the wake of the financial crisis of 2008. The man who had singlehandedly carried the faith of “the rational market” confessed that, “I made a mistake in presuming that the self-interests of organizations, specifically banks and others, were such that they were best capable of protecting their own shareholders and their equity in their firms.”

The revelations around the fraudulent LIBOR fix that are beginning to come forth have been greeted with half the outrage heaped on Bernard Madoff two years ago. Some would suggest that the reason Madoff seems to be the only corrupt financier behind bars is that he stole from the 1%, while the fixers at Barclays and the other banks that manipulated the $360 Trillion derivatives market got away with a mere dismissal and most of their bonuses intact. Eduardo Porter suggests the real reason for our non-chalance.

Perhaps the most surprising aspect of the Libor scandal is how familiar it seems. Sure, for some of the world’s leading banks to try to manipulate one of the most important interest rates in contemporary finance is clearly egregious. But is that worse than packaging billions of dollars worth of dubious mortgages into a bond and having it stamped with a Triple-A rating to sell to some dupe down the road while betting against it? Or how about forging documents on an industrial scale to foreclose fraudulently on countless homeowners?

What is so shocking is that most of what purports to be mainstream economic theory today is based on this notion of rational choice theory. The whole Potemkin Village of Libertarian Free Market theory is based on a concept that takes no account of the tendency of “rational actors” to cheat if they think they can get away with it. Porter again.

Company executives are paid to maximize profits, not to behave ethically. Evidence suggests that they behave as corruptly as they can, within whatever constraints are imposed by law and reputation. In 1977, the United States Congress passed the Foreign Corrupt Practices Act, to stop the rampant practice of bribing foreign officials. Business by American multinationals in the most corrupt countries dropped. But they didn’t stop bribing. And American companies have been lobbying against the law ever since.

Extrapolating from frauds that were uncovered during and after the dot-com bubble, the economists Luigi Zingales and Adair Morse of the University of Chicago and Alexander Dyck of the University of Toronto estimated conservatively that in any given year a fraud was being committed by 11 to 13 percent of the large companies in the country.

This is the basic flaw in the Republican argument that we need less regulation of the financial markets. As Simon Johnson wrote this morning, The Market Has Spoken and It is Rigged. This is the torch the Democrats must carry from now until the election. Mitt Romney is the poster child for Savage Capitalism. His election would signal the end of democracy and the beginning of Oligarchy.

This entry was posted in Economics, Politics and tagged , , , , , , , . Bookmark the permalink.

23 Responses to Rational Markets and Corruption

  1. Rick Turner says:

    And this is the biggest argument against Libertarian philosophy…which would work if human nature could be universally changed over night. It only takes one rotten apple, as it is said, and we have a Wall St., banking system, and government that has been rotting for decades. Not even fit for good cider these days…

  2. len says:

    Rick Turner :It only takes one rotten apple, as it is said, and we have a Wall St., banking system, and government that has been rotting for decades. Not even fit for good cider these days…

    Worse than that, what we have is worldwide. To compete, as a class, they all devolved into the same ape-brain behaviors with externalities that are sophisticated and slick but below, carnal, venal and corrupt. Worse even, they believe confidently that there is nothing the “little people” can do about it. That is why the League of They Who Shop Till They Drop is such a cancer because they seek to emulate what they wish to become and believe they are asserting it in their Facebook postings, wrap themselves in flags, tell the world how much they are for capitalism but against keeping stores open on independence day, but because they are so shallow have yet to admit they are the engine of the very evils they claim to detest.

    Until they see what they are doing to their chilldren, they will lie to the day they die.

    Someone noted on FB that sales of 50 Shades of Gray have done more to revitalize the sex toy industry than any book since Anais Nin. I’m looking forward to see what Callie does with “Nashville”. Will the feminists turn up the heat or salt the water? How do the rational values of choice of choice establish themselves in this marketplace?

  3. Anonymous says:

    “The whole Potemkin Village of Libertarian Free Market theory is based on a concept that takes no account of the tendency of “rational actors” to cheat if they think they can get away with it.”

    In professional sports they have a saying, “If you ain’t cheating, you’re only cheating yourself.”

  4. Ham Niles says:

    I agree with everything here except the idea that electing Mitt would signal the beginning of oligarchy in the US. Dude, it’s already here. Good post, thanks for the excellent ideas. H

  5. morgan s warstler says:

    There is a giant difference between Simple but Final Regulations, and Regulations that require reams of rules making and discretion in tens of thousands of regulators.

    Force banks to keep 100% reserves.

    Run the Fed with a single mandate of a 4.5% NGDP Level Target (accrual)

    REQUIRE FDIC banks to keep their loans on their books.

    Overnight, the problem vanishes.

    Look, Taplin is doing a slight of hand.


    He doesn’t want the problem solved.

    I’m ONLY willing to solve the problem if it t done with simple rules that need very little public employees without any real power.

    If Jon really wants to solve the problem, he’ll do it my way. Find a simple rule and I’ll support it.

  6. Alex Bowles says:

    I just watched Inside Job again. This time I could see how corruption of the academic economics is the thing around which Charles Ferguson built his entire film (key segment starts at 1:22:30). Harvard and Columbia receive especially harsh treatment, but the problem extends beyond these institutions to the profession itself, which, as Ferguson points out, has been selling deregulation hard since the early 1980s.

    Andrew Sheng, a Chief Advisor of the China Banking Regulatory Commission, puts the results in perspective by asking “Why should a financial engineer be paid four to a hundred times more than a real engineer? A real engineer builds bridges, an financial engineer builds dreams. And when those dreams turn out to be nightmares, other people pay for it.”

    Can anyone imagine an actual engineering faculty run by people who led a decades-long charge against the very idea of a uniform building code? Or, for that matter, basic physics? Can we imagine what would happen if they circled wagons around that idea that “self regulation” by nuclear power plant operators was a moral and economic imperative?

    Actually, we don’t need to. The ruins of Fukushima and Port-au-Prince to illustrate what happens when massive and potentially life-threatening structures are setup and run without necessary governance. The 2008 Crash represents the same issue, multiplied by trillions.

    So what was going on among the faculties pushing financial deregulation? Appalling financial conflicts of interest were the most immediate problem Ferguson notes. But the bigger issue is summed up by Charles Morris. Ferguson asks “So, what do you think this says about the economics discipline?” His response, “Well, it has no relevance to anything.”

    What’s worse is that this reality-adverse, faith based approach is actually a point of pride among economists. And if not pride, then certainly professional confidence that this is they way things ought to be. Here’s a roundup of remarks related to this disconnect. In sum, they’re astonishing.

    “Economic theory proper, indeed, is nothing more than a system of logical relations between certain sets of assumptions and the conclusions derived from them… The validity of a theory proper does not depend on the correspondence or lack of it between the assumptions of the theory or its conclusions and observations in the real world.” – William Vickery (Nobel prize, 1997)

    And why not? Because empiricism is superflous. There’s a higher order at work, and not one that ought to be questioned. As noted by Harper’s (2005) “Neoclassical economics – underneath it’s veneer of math and science – is actually a twisted form of Protestant religion in disguise.”

    “Economics, as channeled by its popular avatars in media and politics, is the cosmology and the theodicy of our contemporary culture. More than religion itself, more than literature, more than cable television, it is economics that offers the dominant creation narrative of our society, depicting the relation of each of us to the universe we inhabit, the relation of human beings to God. And the story it tells is a marvelous one. In it an enormous multitude of strangers, all individuals, all striving alone, are nevertheless all bound together in a beautiful and natural pattern of existence: the market. This understanding of markets—not as artifacts of human civilization but as phenomena of nature—now serves as the unquestioned foundation of nearly all political and social debate.

    Neoclassical economics tends to downplay the importance of human institutions, seeing instead a system of flows and exchanges that are governed by an inherent equilibrium. Predicated on the belief that markets operate in a scientifically knowable fashion, it sees them as self-regulating mathematical miracles, as delicate ecosystems best left alone.”

    As economics professor and rising gadfly Steve Keen notes:

    Neoclassical economics has become a religion. Because it has a mathematical veneer, and I emphasize the word veneer, they actually believe it’s true. Once you believe something is true, you’re locked into its way of thinking unless there’s something that can break in from the outside and destroy that confidence.

    Apparently the last four years haven’t been up to that task. At the same time, abstinence of this magnitude does even more to undercut the belief in self-regulating equilibriums than the Great Implosion itself. The Libertarians, of course, will point out that the system failed not because of deregulation, but because deregulation – and the blind faith supporting it – wasn’t pure enough.

    Or rather, that’s what the useful idiots true believers will say. As Ferguson observes, the priests themselves are as corrupt at the Papacy in the 15th century; a time when the Bible could not be read by the laity and offers of absolution were delivered with a list of prices.

    Ferguson, by the way, deserved every ounce of his Oscar, and thanks for placing it in the Public Domain. Ironically, it fits squarely with the original Protestant tradition.

  7. Alex Bowles says:

    Drat – “abstinence” should have been “obstinance”. Indeed, if there’s one thing the financial sector lacks, it’s any hint of self-restraint.

  8. JTMcPhee says:

    At the risk of broken-recordism, one more shot at it:

    Remember: as all the economists in the world (almost) are telling us, the way to “recovery” is through encouraging and fostering and pumping up the malignancy called “growth.” Which only works for maybe another generation or three, as pointed out by a former major-malefactor Bankster, who must have had one of those “Road to Damascus” conversion experiences,who observes the following:

    John Fullerton is a former managing director at JPMorgan. Finance drives economics, he says, and economics largely determines the fate of the planet, yet the resources of the planet are finite. “The notion that exponential growth can go on indefinitely in a finite planet is in violation with arithmetic and basic physics.” As long as growth is the sine qua non of market economic ideology: “We are lost.”

    If we don’t redefine self-interest, said Fullerton, in this conversation recorded in New York in late June, “I think we will look back, and our grandchildren will ask us, What were you thinking?”

    [Assuming our grandchildren are still among the living… I guess that may very well depend on their skills with various weapons, and fang and claw. So we should encourage more hours of education in “World of Warcraft,” and of course the instructional wet dream branded “Call of Duty.”]

    And there’s more similar wisdom, at http://www.thenation.com/blog/168772/are-banksters-redeemable-interview-former-jp-morgan-director-john-fullerton#

    Without a change of heart, http://www.thehumaneleague.com/changeofheart/praise.htm, there will be no change of behavior or of circumstances, in the direction of even survival of a few of us. There’s more than enough of us who are wedded to camo-painted or lipsticked nihilism, or pursuit of personal pleasure, or just lost in tribal dreams of hegemony, to catalyze the advent of the terminal pointlessness of the species. “In the end, there can be only one.” “The one who dies with the most toys, wins…”

    Uhn… O.M.G!!!!!! Have you SEEN what Kim K’s up to today, again?

  9. Alex Bowles says:

    @JTMcPhee Fullerton clearly gets the problem with <a href="http://physics.ucsd.edu/do-the-math/2012/06/ruthless-extrapolation/"ruthless extrapolation.

    Evolutionary processes tend to satisfy minimal requirements to outperform the competition, or to edge out environmental impositions. Human cultural memes aside, there are no deluxe model organisms with far more “adaptiveness” than is needed to get the job done (and procreate). So why would we expect to leapfrog evolution and develop a subtle perceptive tool beyond simple extrapolation. The simple technique is enough to exert powerful anticipatory action relative to our surroundings.

    I think Fullerton is right, but I also happen to think that Tom Murphy (physicist, author of this post, and someone who shares Fullerton’s sentiments) glosses over something important when he disregards cultural memes as examples of second-order evolution – which is to say, objects with adaptive power that responds to more than immediate pressure. The notion that biology isn’t the only determinant, and that our lives are subject to a parallel (and much, much faster) set of evolutionary pressures found in ideas themselves was the essence of Mark Pagel’s remarks in <a href="http://edge.org/conversation/infinite-stupidity-edge-conversation-with-mark-pagel"Infinite Stupidity. When this came up earlier, people up in arms about copyrights managed to miss the deeper import of what he’s pointing out. But I think it’s essential to remember that we can expect “to leapfrog evolution and develop a subtle perceptive tool beyond simple extrapolation.” Not biologically, but culturally.

    I say this because I’ve been working on a program about cartography. To really make sense of the subject, you need to appreciate the way maps function as tools for the mind, and the way their development has followed a path of growing utility that is defined by the ingrained capacities of the human imagination.

    What’s interesting is that these abilities – which include everything from an understanding of ratios and a capacity for abstraction, to the ability to imagine perspectives not our own, and integrate information from these vantages into our own understanding – all emerged at a fairly definite point in time (~50,000 years ago). And while they may have emerged in response to particular challenges, they are not finely tuned to the environment in the same way that the beak of a hummingbird develops in tight symbiosis with the shape of particular flowers. Rather, they provide the building blocks of a kind of general intelligence that can be applied to situations that go far beyond anything that immediate survival pressures would demand.

    For instance, developing telescopes, looking deep into space, and using what we find to update our grandest cosmological conception is very different from an omnivorous disposition that allows us to eat many, many things. Astronomy, in other words, is not what our eyes are “for” in a strict survival / reproduction analysis. And yet, we’re not only capable of doing it, we can derive huge material advantage from the intellectual mastery of our environment that results from this kind of scientific study.

    So my point is that general intelligence – which is quite real – gives us an adaptive capacity that vastly outstrips the mutability that defines living things in general. And this is derived from ideas that we can deliberately accept or reject. Even if we’re biologically programmed to operate in one fashion, culture gives us a means to redirect those impulses in cases where environmental change makes our genetic traits maladaptive.

    Recognizing this means moving past discussion of government in terms of big or small, and towards a framework that assesses degrees of justice, competence, and stability in pursuit of second-order social evolution. Anarcho-libertarianism, by way of contrast, not only rejects the possibility of beneficial – if forceful – intervention in lives and markets defined by short-term, personal interests, it holds that the effort itself is the epitome of immorality.

  10. len says:

    it holds that the effort itself is the epitome of immorality

    Competitors will try to rob you of the advantages of your talent and competence, but most of all of your desire. This is called “jealousy”. It is a primitive behavior but you are conditioned to respond to it as a side effect of giving a damm about the opinion of others. Heel over too far over the other way and you become arrogant.

    It doesn’t matter if you are first rate or second rate. It matters that you get up every time ready to learn and improve. As for your critics, tell them to go fuck themselves. You can be sure they are good at that. A friend of mine is a sculptor. When someone asked him how long it took him to sculpt a piece he was showing he replied, “Thirty five years.”

    As I said, Pagels is wrong. An old folksinger’s 100th birthday has come round. He had something to say about this:

    I hate a song that makes you think that you are not any good. I hate a song that makes you think that you are just born to lose. Bound to lose. No good to nobody. No good for nothing. Because you are too old or too young or too fat or too slim or too ugly or too this or too that…I am out to sing songs that will prove to you that this is your world and that if it has hit you pretty hard and knocked you for a dozen loops, no matter what color, what size you are, how you are built, I am out to sing the songs that make you take pride in yourself and in your work. And the songs that I sing are made up for the most part by all sorts of folks just about like you.

  11. len says:

    Woody Guthrie, BTW. Happy 100th.

    If Obama’s campaign had the moxie they are credited with they’d know they’d get more cred by inviting Arlo and his family to perform at the White House than giving dylan a medal. Arlo still has something to say. That may be what stops them from doing it and that is how I know they are only the lesser of two stupids.

  12. JTMcPhee says:

    @Alex Bowles
    When “ruthless extrapolation,” and “ruthless extraction” and “ruthless consumption” and “ruthless domination,” are the overwhelming cultural memes, with all the seductions of “innovation” and “securitization” and “security-state-ization” and personal titillation, how do 8 billion humans get to the point of “moving past discussion of government in terms of big or small, and towards a framework that assesses degrees of justice, competence, and stability in pursuit of second-order social evolution”? I don’t know — I am just asking. I ask in the hope that that there is a set of answers.

    The generals in the Armies of the Night have figured out how to move the most of us into the dead-end mindset that is profitable to their particular metastatic tumor. Humans are obviously “adaptable,” but without a predisposition toward stability, let alone justice and the rest. What’s the process for instilling the kind of thinking and believing and hoping and planning that gets us to the far side of all those asymptotic-growth-to-Crash graphs that are facing us?

    Seems to me that something necessary is missing in all of this paean-to-innovation ‘n stuff. Like a common inspiration and agreed set of values and a broad commitment to doing all the stuff that’s needed to keep the planet and our “dominant” species alive. Speaking now of stuff like that Aspen conference, and all the other gatherings of navel-gazers that so much tend to validate More Of The Same. Ruthless extrapolation, as it were. How, when so many will be coming to the sense that we are living out actual End Times, “On the Beach” as it were, can the memes be re-set into healthier channels?

    Forgive the re-post, but this is where I get caught up in the temptation to losing myself in Futilitarianism. All this social networking and targeted netpropaganda seems to me to be all or mostly about cynical and structured particularization to individuals, and playing, for profit (as in extracting money/wealth from) to their preferences/prejudices/predilections/peculiarities/peccadilloes/perversions (mostly the ones “modulated” by the limbic system). How much “innovation” is exercised in huge efforts to “monetize” every aspect of the demon’s gift of the internet?

    Without some kind of communitarian and at least commensal animating spirit and agreement, all you got is yet another set of selfish-personal-interest, power-and-money-driven forces added to all the rest of the stuff that’s in action, pandering and wedging and dissimulating away so the players in that domain can have their very own fat-piggy-Kim-Dotcom megayachts and perfect titties to play with. People have to agree to a redefinition of what constitutes “winning,” since we, the species, seem wired to force everything into that kind of model.

    Also seems to me that it may just be magical thinking to imagine that an open door to infinityinnovation, including stuff like the ability to literally play Genesis with our own genetic material, to grow horns or giant dicks or whatever else tickles the fancy, is not even a meta-pathway to the stuff of sustainability, let alone survival. “Avatar” is no “Leviathan,” but there’s buckets of little meme-nuggets in among the triteness to maybe make one think: http://www.imdb.com/title/tt0499549/synopsis Was it just the 3D and titty-views that resulted in the popularity of the movie? Or a bit of something else? “We” don’t have the vaguest kind of World Consciousness that might give us a prayer of a happy ending, for all that the ‘net offers a Tantalus’s pool of cool, clear water, and the sweetest of low-hanging fruit… http://en.wikipedia.org/wiki/Tantalus.

    But maybe there’s some innovation that would encourage that bigger kind of thinking and believing? Or is there already too much noise for any of that kind of signal to register?

  13. Alex Bowles says:


    “We” don’t have the vaguest kind of World Consciousness that might give us a prayer of a happy ending

    If by “we” you mean those of us in the rich world, you may be right. But in the grander scheme, this appears not be the case.


    Remarkably, people in the less comfortable parts of the world are far more conscientious about their impact. The idea that people only worry about the environment after they’ve made their money doesn’t hold up. If anything, genuine concern appears to develop where people are still having to think about the tradeoffs they make on the way up, as opposed to those who will only think as far as permitted by what they’ve already attained.

  14. JTMcPhee says:

    @Alex Bowles

    Germany, I hear, is a very clean country. Unlike the quarters of Paris, where the street signs warn you to “Fait Attention Aux Crottes!,” which my escort rendered from the colloquial as “Don’t Step In The Dog Shit.” Whether some Germans keep their streets clean and forests manicured (having decimated them via air pollution and war and consumption several times) out of OCD, or something more moral, with a long view attached, I don’t know. The contrast between the east and west ends of the island of Hispaniola (the Dominican Republic and Haiti) might also be illustrative, of something about the Great Complexities of History and the Great Game maybe, and/or the many bits of the real nature of Us, the Beast.

    Some of us still look for clues that maybe there are genetic bits that, taken together, may eventually overcome the Badness coding. I don’t know about that, either. But here is my clue for the day, which I am sure some Innovator will examine and find the inspiration to turn it into something monetizable.

    A brief reflection on “inequity aversion,” with cute and informative video at the link:

    [W]e did a study in which capuchin monkeys received either a grape or a piece of cucumber for a simple task.

    If both monkeys got the same reward, there never was a problem. Grapes are by far preferred (as real primates, like us, they go for sugar content), but even if both received cucumber, they’d perform the task many times in a row.

    However, if they received different rewards, the one who got the short end of the stick would begin to waver in its responses, and very soon start a rebellion by either refusing to perform the task or refusing to eat the cucumber.

    This is an “irrational” response in the sense that if profit-maximizing is what life (and economics) is about, one should always take what one can get. Monkeys will always accept and eat a piece of cucumber whenever we give it to them, but apparently not when their partner is getting a better deal. In humans, this reaction is known as “inequity aversion.”


    One tiny co-thought: As the fraudsters, ever attentive to their “reputation” as presented by their host of Spinpeople, go about maximizing their predatory take, at some point there appears to be an apoptotic cue that causes the Goose who lays the Golden Eggs, the ordinary people who do all the little labors that feed us and clothe us and treat our illnesses and all that, to just kind of sicken and die. Not much nutrition in a slice of cucumber.

    But then those not so strongly affected by empathy, the ones who rise in the System, will have got their personal stash and been on their way out, free from consequences of any sort. God rot their souls…

  15. JTMcPhee says:

    And if you don’t have time for the whole 17 minutes, jump to 12:32 for the monkey business. But the whole thing is worth the few minutes it takes to watch, I think, and why does the LIBOR thing, as a meme for the whole financialization gang-rape, with those “getting you coffees” emails, come to mind as the ethology unfolds?

  16. len says:

    A convincing defeat of Mitt Romney may be just such a cue. When money can’t buy an election, they pay attention.

    Note the increase of green spaces in NYC. Sometimes people do get tired of the poo.

  17. JTMcPhee says:

    My inclination would be to bet that if money failed to buy THIS election, well, the solution is obviously to pour more money into the next one. See, e.g., our Governator Rich “Skeletor/Voldemort” Scott, down here in FL — personal outlay of about $100 million and of course a Dem candidate archly named “Sink” who could manage no better, in a state with a majority of registered Dems, than a near miss. But then like a lot of Dem candidates (Kerry, Gore?) I bet in her heart she really did not want the ugly job of facing down a scum-sucking legislature full of Gerrymanipulated, hyper-lobbied, Permanent “Republicans,” every stinking, good-ol’-boy, business-as-usual day up there in the far-away capitol city.

    Not too many Good People have either the desire and the durable strength to Rule Wisely over time, or the honor to remain untainted when sent down to sleep with “peppered whores” every night…

  18. Fentex says:

    What is so shocking is that most of what purports to be mainstream economic theory today is based on this notion of rational choice theory.

    That theory is wrong, but not for the reason you’re meaning here. Humans are rationalising, not rational creatures, but that makes no difference to economic theory.

    We can be be perfectly rational and the school that argues deregulation is inevitably good because it reduces friction and allows the accumulation of individual choices to bring forth the most efficient use of resources by delivering the most accurate possible and undistorted valuations would still be wrong.

    Because among rational actors (and irrational actors) cheating still works.

  19. morgan s warstler says:

    Apparently, we just need to kill the Baby Boomers!


    Man, you expected so much more from yourselves didn’t you?

  20. len says:

    morgan s warstler :</strongMan, you expected so much more from yourselves didn’t you?

    Not since 1975. But the joy we feel in watching the Web Generation collectively rush over the cliff to the electronica beat is overwhelming in the same way that we watched our parents wake up to the fact that they had been electing crooks just to show the hippies who was really in charge. And now you’ll do it again just to prove your crooks are smarter crooks.

    “Second verse, same as the first.”

  21. Rick Turner says:

    Morgan, you seem to have confused us with our more populous age equals who elected Reagan and the Bushes Senior and Junior. Our choices…Carter and Clinton…both did pretty well, especially Clinton with the economy. If the counterculture had prevailed, then we’d be way ahead of the game now.

Leave a Reply