Reply To: Questions regarding DPF.

[Rezwan]

Brian H wrote:
Your fear of big bizniss is, I think, ideological. The vast bulk of companies are small to medium-sized, and they employ the great majority of people. Profit-making is getting paid for the added value you contribute, whether that’s physical change, relocation, distribution, or anything else others would prefer to pay for rather than do themselves.

I’m all for people getting paid for added value. Also for a diverse ecology of small and medium-sized companies. Long tail and micro-finance, markets which accurately reflect preference and value.

In numbers, most companies are small and medium, and that’s great. But there’s something else going on here. Some “smart” guys acting like they are adding value, when they’re not. Taleb (“Black Swan“) puts it this way:

Globalization creates interlocking fragility, while reducing volatility and giving the appearance of stability. In other words it creates devastating Black Swans. We have never lived before under the threat of a global collapse. Financial Institutions have been merging into a smaller number of very large banks. Almost all banks are interrelated. So the financial ecology is swelling into gigantic, incestuous, bureaucratic banks – when one fails, they all fall. The increased concentration among banks seems to have the effect of making financial crises less likely, but when they happen they are more global in scale and hit us very hard. We have moved from a diversified ecology of small banks, with varied lending policies, to a more homogeneous framework of firms that all resemble one another. True, we now have fewer failures, but when they occur ….I shiver at the thought.

Banks hire dull people and train them to be even more dull. If they look conservative, it’s only because their loans go bust on rare, very rare occasions. But (…)bankers are not conservative at all. They are just phenomenally skilled at self-deception by burying the possibility of a large, devastating loss under the rug.

The government-sponsored institution Fannie Mae, when I look at its risks, seems to be sitting on a barrel of dynamite, vulnerable to the slightest hiccup. But not to worry: their large staff of scientists deemed these events “unlikely”.

There is no way to gauge the effectiveness of their lending activity by observing it over a day, a week, a month, or . . . even a century!

(…) the real- estate collapse of the early 1990s in which the now defunct savings and loan industry required a taxpayer-funded bailout of more than half a trillion dollars. The Federal Reserve bank protected them at our expense: when “conservative” bankers make profits, they get the benefits; when they are hurt, we pay the costs.

Once again, recall the story of banks hiding explosive risks in their portfolios. It is not a good idea to trust corporations with matters such as rare events because the performance of these executives is not observable on a short-term basis, and they will game the system by showing good performance so they can get their yearly bonus. The Achilles’ heel of capitalism is that if you make corporations compete, it is sometimes the one that is most exposed to the negative Black Swan that will appear to be the most fit for survival.

As if we did not have enough problems, banks are now more vulnerable to the Black Swan and the ludic fallacy than ever before with “scientists” among their staff taking care of exposures. The giant firm J. P. Morgan put the entire world at risk by introducing in the nineties RiskMetrics, a phony method aiming at managing people’s risks, causing the generalized use of the ludic fallacy, and bringing Dr. Johns into power in place of the skeptical Fat Tonys. (A related method called “Value-at-Risk,” which relies on the quantitative measurement of risk, has been spreading.)

Brian H wrote: There is constant turnover in who’s successful; e.g., less than 20% of the members of the Fortune 500 stay on the list 20 years.

Not a compelling metric. US population is over 300,000,000 now. So when the dude slips from the top 500 down to the top 10,000, he’s still in the top .003%

But it’s not about the individuals. It’s about the corporations. Get ’em to be triple bottom line, lose the corporate socialism, and we’re good. Meanwhile, take away some of the limitations on people, which hamper their effectiveness in the market (like limits on investing to “accredited investors” and… 2 tiered currency would be useful, too. Global and local. We have hardly begun to exploit long-tail markets. and… ).

I consider myself a capitalist. Taleb again:

Do not let someone making an “incentive” bonus manage a nuclear plant – or your financial risks. Odds are he would cut every corner on safety to show “profits” while claiming to be “conservative”. Bonuses do not accommodate the hidden risks of blow-ups. It is the asymmetry of the bonus system that got us here. No incentives without disincentives: capitalism is about rewards and punishments, not just rewards.