Paul M. Jones

BERNIE MADOFF	SOCIAL SECURITY
Takes money from investors with the promise that the money will be invested and made available to them later	Takes money from wage earners with the promise that the money will be invested in a "Trust Fund" and made available later.
Instead of investing the money Madoff spends it on nice homes in the Hamptons and yachts.	Instead of depositing money in a Trust Fund the politicians use it for general spending and vote buying.
When the time comes to pay the investors back Madoff simply uses some of the new funds from newer investors to pay back the older investors.	When benefits for older investors become due the politicians pay them with money taken from younger and newer wage earners to pay the geezers.
When Madoff's scheme is discovered all hell breaks loose. New investors won't give him any more cash.	When Social Security runs out of money they simply force the taxpayers to send them some more.
Bernie Madoff is in jail.	Politicians remain in Washington .

via Institute for Truth in Accounting - Blog.

The paper How Complex Systems Fail by Richard Cook should be required reading for anyone in programming or operations. Hell, it should be required reading for most everyone. You should read the whole paper (it's very short at under five pages), but here are the main points:

1. Complex systems are intrinsically hazardous systems.
2. Complex systems are heavily and successfully defended against failure.
3. Catastrophe requires multiple failures – single point failures are not enough.
4. Complex systems contain changing mixtures of failures latent within them.
5. Complex systems run in degraded mode.
6. Catastrophe is always just around the corner.
7. Post-accident attribution accident to a ‘root cause’ is fundamentally wrong.
8. Hindsight biases post-accident assessments of human performance.
9. Human operators have dual roles: as producers & as defenders against failure.
10. All practitioner actions are gambles.
11. Actions at the sharp end resolve all ambiguity.
12. Human practitioners are the adaptable element of complex systems.
13. Human expertise in complex systems is constantly changing
14. Change introduces new forms of failure.
15. Views of ‘cause’ limit the effectiveness of defenses against future events.
16. Safety is a characteristic of systems and not of their components.
17. People continuously create safety.
18. Failure free operations require experience with failure.

Points 2 and 17 are especially interesting to me. It's not that people can build complex systems that work; instead, it is that people have to actively prevent system failure. Once you stop maintaining the system, it begins to fail. It sounds like thermodynamics; without a constant input of energy from people, the mostly-orderly complex system will descend into increasing disorder and failure.

James Madison would have to revise--or possibly burn--Federalist No. 10 if he were forced to account for the new phenomenon of the government itself becoming the faction decisively shaping its own policy and conduct. (See “Madison’s Nightmare” in City Journal’s 2009 special issue, “New York’s Tomorrow.”) This faction dominates because it’s playing a much longer game than the politicians who come and go, not to mention the citizens who rarely read the enormous owner’s manual for the Rube Goldberg machine they feed with their dollars. They rarely stay outraged long enough to make a difference.

via The Big-Spending, High-Taxing, Lousy-Services Paradigm by William Voegeli, City Journal Autumn 2009.

Sternberg's premise is that stupidity and intelligence aren't like cold and heat, where the former is simply the absence of the latter. Stupidity might be a quality in itself, perhaps measurable, and it may exist in dynamic fluxion with intelligence, such that smart people can do really dumb things sometimes and vice versa.

...

Perkins lists eight deadly sins of the stupid smart person, which seem to sum it all up rather elegantly: impulsiveness (doing something rash), neglect (ignoring something important), procrastination (actively avoiding something important), vacillation (dithering), backsliding (capitulating to habit), indulgence (allowing oneself to fall into excess), overdoing (like indulgence, but with positive things) and walking the edge (tempting fate). That sounds like my entire life, actually. Yes, that explains a lot.

...

After reading Stanovich, the proper utility of game theory seems to be, not the study of human interactions, but the study of why game theory doesn't work in real life -- to wit: the study of human stupidity, including the stupidity of those who keep trying to apply game theory to real human behavior. Stanovich also contributes the excellent term "dysrationalia." A word to keep and to use.

via Salon.com Books | "Why Smart People Can Be So Stupid," by Robert J. Sternberg.

More important still, the propounders of the individualist work ethic, from Alexander Hamilton onward, had it right: a free society isn’t one that alleviates the burden of supporting ourselves and our families, but rather one that provides the opportunity to labor in a way that brings to light whatever human excellence may lie within us--a way that perhaps even adds to the sum of human progress. As opposed to FDR’s immense governmental machine throbbing mightily at the end of history, how much grander is Edmund Burke’s vision of society as “a partnership in all science; a partnership in all art; a partnership in every virtue and in all perfection.” It is a vision in which some can be the Titans Roosevelt rejected--not just the Morgans and the Vanderbilts that New York produced, but also its Edith Whartons and its Herman Melvilles. Most crucially, all can be humans, free citizens with a sense of purpose, not cogs.

via The Obsolete New York Model by Myron Magnet, City Journal 16 July 2009.

We've reached the point where police have no qualms about a using heavily armed police force trained in military tactics to serve a search warrant on a suspected nonviolent marijuana offender. And we didn't get here by accident. The war on drugs has been escalating and militarizing for a generation. What's most disturbing about that video isn't the violence depicted in it, but that such violence has become routine.

via A Drug Raid Goes Viral - Reason Magazine.

Gambling With Other People’s Money is a sensible, accessible, intuitively appealing treatise from Russell Roberts on the financial collapse. It centers on the incentives and behaviors of those involved, not on the financial instruments they used.

Short version: if you have the idea that the government will bail you out when you are about to lose, you feel safer being reckless. You are even more reckless when you get to keep all the upside, and lose nothing on the downside, because someone else bails you out when you lose. The gains are private, and the losses are public. This, combined with bad regulation and other bad incentives, shows Washington and Wall Street to be tightly intertwined; they are together the fox, and we the people are the chickens in the henhouse. We taxpayers are the ones who pay for the bailout, a huge transfer of wealth to the already-wealthy bailed-out lenders.

Following are many excerpts that I found especially good. The entire conclusion “Where Do We Go From Here?” in particular is excellent, and defies excerpting.

Until we recognize the pernicious incentives created by the persistent rescue of creditors, no regulatory reform is likely to succeed.

…

Capitalism is a profit and loss system. The profits encourage risk taking. The losses encourage prudence. Eliminate losses or even raise the chance that there will be no losses and you get less prudence. So when public decisions reduce losses, it isn’t surprising that people are more reckless.

…

Only at the very end, when collapse was imminent and there was doubt about whether Uncle Sam would really come to the rescue, did the players at the table find it hard to borrow and gamble with other people’s money.

…

Did this history of government rescuing creditors and lenders encourage the recklessness of the lenders who financed the bad bets that led to the financial crisis of 2008?

For the GSEs’ creditors, the answer is almost certainly yes. Fannie Mae and Freddie Mac’s counterparties expected the U.S. government to stand behind Fannie and Freddie, which of course it ultimately did. This belief allowed Fannie and Freddie to borrow at rates near those of the Treasury.

…

Why didn’t lenders to Fannie and Freddie require a bigger premium as Fannie and Freddie took on more risk?

The answer is that they saw lending to the GSEs as no riskier than lending money to the U.S. government. Not quite the same, of course. GSEs do not have quite the same credit risk as the U.S. government. There was a chance that the government would let Fannie or Freddie go bankrupt. That’s why the premium rose in 2007, but even then, it was still under 1 percent through September 2008.

…

But the owners’ salaries were ultimately coming out of the pockets of taxpayers. What the owners were doing was borrowing money to finance their salaries, money that the taxpayers guaranteed. When the S&Ls failed, the depositors got their money back, and the owners had their salaries: The taxpayers were the only losers.

This kind of looting and corruption of incentives is only possible when you can borrow to finance highly leveraged positions. This in turn is only possible if lenders and bondholders are fools--or if they are very smart and are willing to finance highly leveraged bets because they anticipate government rescue.

…

The standard explanations for the meltdown on Wall Street are that executives were overconfident. Or they believed their models that assumed Gaussian distributions of risk when the distributions actually had fat tails. Or they believed the ratings agencies. Or they believed that housing prices couldn’t fall. Or they believed some permutation of these many explanations.

These explanations all have some truth in them. But the undeniable fact is that these allegedly myopic and overconfident people didn’t endure any economic hardship because of their decisions. The executives never paid the price. Market forces didn’t punish them, because the expectation of future rescue inhibited market forces. The “loser” lenders became fabulously rich by having enormous amounts of leverage, leverage often provided by another lender, implicitly backed with taxpayer money that did in fact ultimately take care of the lenders.

…

Bad regulation and an expectation of creditor rescue worked together to destroy the housing market.

…

The buyer of a house who puts 3 percent down and borrows the rest is like the poker player. Being able to buy a house with only 3 percent down, or ideally even less, is a wonderful opportunity for the buyer to make a highly leveraged investment. With little skin in the game, the buyer is willing to take on a lot more risk when buying a house than if he had to put up 20 percent. And for many potential homebuyers, a low down payment is the only way to sit at the table at all.

…

The second reason is that you will be very comfortable lending the money if you know you can sell the loan to someone else. Who is that someone? Between 1998 and 2003, just when the price of houses really started to take off (see figure 2), the most frequent buyers of loans were the GSEs Fannie Mae and Freddie Mac.

Fannie and Freddie bought those loans with borrowed money. Fannie and Freddie were able to borrow the money because lenders were confident that Uncle Sam stood behind Fannie and Freddie.

…

But Fannie and Freddie (created in 1970) were not the textbook creations of economists. At some point, Fannie and Freddie stopped acting like models in a textbook and became something more than conduits. Politicians realized that steering Fannie and Freddie’s activities produced political benefits. And Fannie and Freddie found it profitable to be steered.

…

The politicians told Fannie and Freddie to be a little more flexible with their guidelines. As a result, more people got to own houses and the politicians got to take the credit without having to raise taxes or take away any politically provided goodies from anyone else.

Fannie and Freddie’s increases in loan purchases, especially loans to low-income borrowers, helped inflate the housing bubble. That bubble in turn made the subprime market more attractive and profitable to lenders. It also set the stage for the collapse. Housing policy interacting with the potential for creditor rescue pushed up housing prices artificially. When it all fell apart, the taxpayer paid (and is still paying) the bill.

…

With the encouragement of politicians from both parties, Fannie and Freddie relaxed their underwriting standards, the requirements they placed on originators before they would buy a loan. They called it being more “flexible.”

…

When the government implicitly backed Fannie and Freddie, it severed the usual feedback loops of a market system.

…

Consider an investing odd couple: the Chinese government on the one hand and my father, a cautious investor in his 70s, on the other. Both invested in Fannie and Freddie bonds because they paid more interest than Treasuries and were probably just as safe. They weren’t paying attention to what was going on with Fannie and Freddie’s portfolio of loans because they didn’t need to. They counted on the implicit guarantee. It was a free lunch for my father and the Chinese--a good return without any risk.

…

The availability of piggyback loans and federal and state programs to help people buy houses with no money down did much to create homeowners with little or no home equity, the proximate cause of the crisis.

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For those who accept this narrative, the subprime collapse is a lesson in hubris, greed, and myopia--irrational exuberance run wild. The investment bankers believed their risk models that said that the AAA portions of mortgage-backed securities were safer than safe--and that the risk of bankruptcy was therefore very small.80 This failure of imagination, this failure to appreciate the real odds of a housing collapse, explains part of the enthusiasm investors had for an asset that was appreciating year after year.

One problem with this explanation is that many practitioners were surely aware of the shortcomings of their models. Consider Riccardo Rebonato, the chief risk officer of the Royal Bank of Scotland (RBS). In his thoughtful book, The Plight of the Fortune Tellers, written before the crisis, he argues that the standard measures of risk, such as value at risk, were not as reliable as they seemed and that the whole enterprise of risk management is less scientific than it appears.81 I presume that Rebonato knew that RBS was on thin ice as it expanded its purchases of mortgage-backed securities. Shortly after Rebonato’s book was published, the Bank of England took over RBS because of the collapse in the value of RBS’s investments. I suspect Rebonato warned his bosses plenty about the risks they were taking. They either viewed the situation differently or their incentives reduced the appeal of prudence.

…

When everyone is picking up nickels in front of the steamroller, the odds of a complete rescue are higher. So when a bunch of firms got flattened, Uncle Sam came to the rescue and used taxpayer money to cover the hospital bills.

As in the Fannie and Freddie story, the firms aren’t the real financers of the salaries associated with picking up nickels. The taxpayers ultimately fund picking up of nickels, and the taxpayers get flattened.

…

But as I have shown, the key players weren’t reckless with their own money. They made sure to invest it elsewhere. When it was their own money, they picked up quarters rather than nickels in markets that were relatively free from steamrollers. And they made sure that regulations that might have restrained their ability to exploit the system (looser capital requirements) were relaxed, so they could effectively use taxpayer money instead of their own to fund the risky investments.

…

An unpleasant but unavoidable conclusion of this paper is that Wall Street was (and remains) a giant government-sanctioned Ponzi scheme. Homebuyers borrowed money from lenders who got their money from Fannie Mae, Freddie Mac, and banks that borrowed money from investors who expected to be reimbursed by the politicians who took that money from taxpayers. Almost everyone made money from this deal except the group left holding the bag--the taxpayers. There is an old saying in poker: If you don’t know who the sucker is at the table, it’s probably you. We are the suckers. And most of us didn’t even know we were sitting at the table.

The International Monetary Fund board has approved a $40 billion bailout for Greece, almost one year after the Senate rejected my amendment to prohibit the IMF from using U.S. taxpayer money to bailout foreign countries.

Congress didn’t learn their lesson after the $700 billion failed bank bailout and let world leaders shake down U.S taxpayers for international bailout money at the G-20 conference in April 2009. G-20 Finance Ministers and Central Bank Governors asked the United States, the IMF’s largest contributor, for a whopping $108 billion to rescue bankers around the world and the Obama Administration quickly obliged.

Rather than pass it as stand-alone legislation, President Obama asked Congress to fold the $108 billion into a war-spending bill to send money to our troops.

It was clear such an approach would simply repeat the expensive mistake of the failed Wall Street bailouts with banks in other nations. Think of it as an international TARP plan, another massive rescue package rushed through with little planning or debate. That’s why I objected and offered an amendment to take it out of the war bill. But the Democrat Senate voted to keep the IMF bailout in the war spending bill. 64 senators voted for the bailout, 30 senators voted against it.

Only one year later, the IMF is sending nearly $40 billion to bailout Greece, the biggest bailout the IMF has ever enacted.

Right now, 17 percent of the IMF funding pool that the $40 billion bailout is being drawn from comes from U.S. taxpayers.

via U.S. taxpayers are helping finance Greek bailout | The Daily Caller - Breaking News, Opinion, Research, and Entertainment.

This is a good line:

The eurozone, as I’ve said from the start, was ill-conceived, and for a very simple reason. With few exceptions, a currency should only be as widespread as a labor force is mobile.

via Pajamas Media » So Long, and Thanks for all the Drachmae.

Washington is full of people who insist they're in control and who go to great lengths to display their power. It's that no one takes responsibility and authority. Washington daily delivers to the people two stark and utterly conflicting messages: "We control everything" and "You're on your own."

via Peggy Noonan: The Big Alienation - WSJ.com.