Daniel Boone was America’s first Libertarian. Whenever he saw smoke rising from a neighbor’s cabin, he moved his family west. Government wasn’t the problem, government wasn’t the solution – at least until the Indians came a’callin’. Oliver Wendell Holmes, Jr., appointed to the Supreme Court at age 62, once said “In the law, an ounce of history is worth a pound of logic.”

Today’s problems are far too complex, critical, and urgent to be solved by either Libertarians or logic – or even lawyers. We need to use the best science available to design and test government’s moves against present and emerging societal (and planetary) problems. And those sciences aren’t biology and physics. They’re systems theory, systems dynamics, and computer simulation, among others – the whole lot of the sciences developed since World War II. Names like Norbert Weiner,  John von Neumann, Stafford Beer, and Jay Forrester are not familiar to the lawyers who make up the vast majority of legislators and staff on Capitol Hill. Such subjects don’t come up in law school – ever!

Take global climate change (Please!). Last week Steven Pearlstein of the Post wrote a column about the complexity of the Waxman-Markey bill. In it he says:

“There remains a robust argument over whether the American Clean Energy and Security Act of 2009 represents a crucial step in preserving life as we know it. But there is no question that there are few pieces of legislation that are likely to have a more profound effect on the U.S. economy. It would bring about dramatic changes in the relative prices of energy and goods produced by energy-hungry industries. It would redistribute trillions of dollars in business sales and household income and generate hundreds of billions in government revenue. And it would represent the most dramatic extension of government’s regulatory powers into the workings of the economy since the early days of the New Deal.
“For all that, there are probably not more than a few hundred people who really understand what’s in this legislation, how it would work and what its impact is likely to be. As it moves through the legislative process, it’s worthy of closer attention.
“The other thing to say about it is that it is a badly flawed piece of public policy. It is so broad in its reach and complex in its details that it would be difficult to implement even in Sweden, let alone in a diverse and contentious country like the United States. It would create dozens of new government agencies with broad powers to set standards, dole out rebates and tax subsidies, and pick winning and losing technologies, even as it relies on newly created markets with newly created regulators to set prices and allocate resources. Its elaborate allocation of pollution allowances and offsets reads like a parody of industrial policy authored by the editorial page writers of the Wall Street Journal. The opportunities for waste, fraud and regulatory screwup look enormous.”

(Another article in the Post, well worth reading, says “The proposal is far more complex than anything tried before in this country, and a close parallel in Europe turned out to be seriously flawed.”)

I like Pearlstein; I don’t find him an ideologue at all. When he’s nervous, I’m nervous. And the entire column is worth reading – twice. But there’s one sentence that’s entirely wrong: “For all that, there are probably not more than a few hundred people who really understand what’s in this legislation, how it would work and what its impact is likely to be.”

Unless and until someone tells me that there’s a very good simulation model of the US economy, and that Waxman-Markey has been plugged into it under a broad variety of assumptions, I don’t think that there’s ANYONE who understands how it would work and what its impact is likely to be!

Wanna bet? Wanna bet the economy or the planet?

An article in Friday’s Post reports that “The board in charge of sanctioning mortgage lenders who violate Federal Housing Administration policies is ineffective and slow at a time when the volume of loans backed by the agency is exploding, according to an inspector general’s report scheduled for release today.” This board has ruled on only 94 cases since October, although 12,641 lenders do business with FHA.

I began to wonder if ANYONE had “the big picture” of how the Federal Government interacts with the financial sector’s myriad actors. While I’d love to see a serious attempt at simulating the overall system, at minimum we need an Enterprise Architecture for the government side. And we know how to do that!

The article continues: “The concern is that some lenders may be using the same abusive tactics that contributed to the collapse of the subprime market and that the FHA may not have the resources or policies to stop them and protect itself against losses. The agency insures lenders against defaults.” So here we go again!

An “Enterprise Architecture” is a set of models of the enterprise showing the relationships between its people, processes, and information. That’s a simple definition – the topic gets into the weeds quickly, as you’d expect from a discipline developed at the Pentagon.

But EA is spreading: the Clinger-Cohen Act of 1996 mandated EA programs at each agency, sponsored by the local Chief Information Officer (CIO). There’s a Federal Enterprise Architecture Framework (FEA) issued by the CIO Council in 1999 to standardize it across agencies. And now OMB requires an EA for funding approval and oversight. And once OMB requires something, it’s really in!

That means we have a language, and a community of those who speak it, that can accurately describe “the people, processes, and information” involved in the oversight of the financial system. With luck, EA might also describe the financial system itself!

And if we had common understandings of how the system works, and graphic displays of the parts and their interactions, and maybe even color coded indications of the competence of the regulators (the Mortgage Review Board would be RED), maybe we’d have a better handle on how to fix it. What a concept!

Just google “enterprise architecture for beginners” for starters.

There are many good reasons to do what it takes to come up with a financial system that’s “fail-safe.” One of the best is that then maybe China will keep investing in America.

A recent article in the New York Times magazine, The China Puzzle by David Leonhardt, talks about how intertwined America’s economy is with that of China. I find it really scary, even though it ends on a hopeful note.

Some selected quotes:

“Over the past decade, China and the United States have developed a deeply symbiotic, and dangerous, relationship. China discovered that an economy built on cheap exports would allow it to grow faster than it ever had and to create enough jobs to mollify its impoverished population. American consumers snapped up these cheap exports — shoes, toys, electronics and the like — and China soon found itself owning a huge pile of American dollars. Governments don’t like to hold too much cash, because it pays no return, so the Chinese bought many, many Treasury bonds with their dollars. This additional demand for Treasuries was one big reason (though not the only reason) that interest rates fell so low in recent years. Thanks to those low interest rates, Americans were able to go on a shopping spree and buy some things, like houses, they couldn’t really afford. China kept lending and exporting, and we kept borrowing and consuming. It all worked very nicely, until it didn’t… The most obviously worrisome part of the situation today is that the Chinese could decide that they no longer want to buy Treasury bonds.” [Emphasis nervously added]

“Were China to cut back sharply on its purchase of Treasury bonds, it would send the value of the bonds plummeting, hurting the Chinese, who already own hundreds of billions of dollars’ worth. Yet Wen’s comments, which made headlines around the world, did highlight an underlying truth. The relationship between the United States and China can’t continue on its current path.” [Emphasis added]

“Throughout most of the 1990s, China’s current account surplus — the value of exports minus the value of imports — equaled less than 2 percent of its gross domestic product. As late as 2001, this surplus was only 1.3 percent of G.D.P. But then it began soaring. Last year, it was 10 percent of G.D.P., according to the World Bank. In more concrete terms, China sold $338 billion worth of goods to American consumers and business, more than the combined annual revenue of Microsoft, Apple, Coca-Cola, Boeing, Johnson & Johnson and Goldman Sachs. [Emphasis added!] American businesses sold only $71 billion to the Chinese.”

“At the end of a discussion with Lardy [Nicholas Lardy, a China expert at the Peterson Institute for International Economics in Washington] about the imbalances between the U.S. and China, I asked him what forms of leverage he thought the Obama administration had. ‘We have no leverage,’ he replied.”

A recent story in The Business Times says that China is still buying, and as of March had $767.9 Billion in Treasuries. That may not sound like a lot of money to you these days, but I’m still working on my first $1 million!

Leonhardt’s concern is that inflation caused by our stimulus packages will bring a decline in the value, and thus the desirability, of the Treasuries. Might happen.

MY concern is that the Chinese might also recognize that the American economic system is inherently unstable, since we’re still allowing (and indeed encouraging the growth of) financial institutions that are “Too Big To Fail.”

And have you read The Black Swan about unlikely events that aren’t planned for? And do you know about chaos theory, how sometimes things don’t end with a whimper, but with a bang?

And so if AMERICA remains “Too Big To Fail,” then a sensible policy by the Chinese would be to pull out, slowly if possible, more rapidly if necessary.

I’m for a “fail-safe” financial system. Now.

On May 9th, a Bloomberg News headline read: “Obama Administration Said to Favor Fed as Systemic Risk Agency.”

The article says that one candidate for Systemic Risk Agency (or SRA) is the Federal Reserve Bank. Others in the Administration favor a council of regulators. That would be an SRC, or Systemic Risk Council. This will take awhile to sort out.

And the article goes on to quote Senator Dodd (D, CT): “Senate Banking Committee Chairman Christopher Dodd said in a May 6 hearing that ‘It is my preference that authority not lie in any one body; we cannot afford to replace Citi-sized financial institutions with Citi-sized regulators,’ referring to Citigroup Inc., one of the largest U.S. financial firms.”

Barney Frank talked about systemic risk regulators several months ago. A Systemic Risk Regulator would be designed to assure that all those financial entities that are “too big to fail” wouldn’t even get CLOSE to failing, ever again.

MY problem is that any reasonable person would want to get rid of the systemic risk to the financial system, not regulate or oversee it. That reasonable person would want to break up any entity that was “too big to fail.” Is that rocket surgery?

Another Bloomberg article purports to report back from 2088 about our financial crisis and its aftermath. Deeply suspicious of government action, the article lists several unintended consequences, and starts with this truism: “The U.S. Congress, which excels at preventing the last crisis from recurring, enacted new rules and regulations before the last bank had extricated itself from the government’s grip.” [Emphasis added]

We shouldn’t settle for a good faith effort to try to create ways to restrain firms that are Too Big To Fail. We don’t just want to avoid repeating this financial meltdown. We need to avoid such failures no matter what. We need a financial system that’s fail-safe. “Fail-Safe” is not a new idea.
And has America ever before faced this issue of keeping corporate entities from becoming too large and too powerful? Why, yes. We called the issue “monopoly” and the laws “antitrust laws.” The Wikipedia entry for the Sherman Antitrust Act tells you more than you want to know.

The (several) antitrust laws were designed to keep large businesses from harming consumers by monopolizing trade and thereby becoming able to set prices without competition. Before it atrophied, there used to be an Antitrust Division within the Justice Department, believe it or not!

And if America decided a century ago to set limits to corporate power in order to protect consumers, why can’t we do so today to protect the entire financial system?

Why can’t we aim for a financial system that’s fail-safe? Shouldn’t that be our design goal?

Design Issues in Government (DIG it!)

As the world’s problems grow more complex, more urgent, and more substantial, governmental responses must keep pace.
The design of governmental responses to issues such as the financial meltdown and perhaps the global meltdown is increasingly an issue – terms like “unintended consequences” are becoming more common in the press.
The “systems sciences” – what Herbert Simon wrote about in The Sciences of the Artificial (see www.amazon.com/Sciences-Artificial-Herbert-Simon/dp/0262691914/ref=cm_cr_pr_product_top) – are tools that should be brought to bear on the design of government – from cybernetics to systems dynamics, Washington needs all the help it can get.
Here are just a few of the issues in the news on November 14th, 2008, where deeper understanding of the problems, and better design, would have assured a better outcome.
(A) Nebraska’s Safe Haven Law allows parents to abandon teenagers at hospitals. See http://www.npr.org/templates/story/story.php?storyId=96993706
(B) AIG to Pay Millions To Top Workers — Move Comes on Heels Of Revised Bailout (Washington Post, November 14, 2008). See www.washingtonpost.com/wp-dyn/content/article/2008/11/13/AR2008111304446.html
(C) The Washington Post’s Stephen Pearlstein on the need to “fix” the rules of international capitalism. See www.washingtonpost.com/wp-dyn/content/article/2008/11/13/AR2008111303901_pf.html
(D) Aid to Fannie, Freddie May Top Expectations (Washington Post). See www.washingtonpost.com/wp-dyn/content/article/2008/11/13/AR2008111303799.html. Three paragraphs from this story illustrate the problem:
(1) “’Fannie Mae and Freddie Mac are completely exposed to the housing market,’ said Howard Shapiro, an analyst at Fox-Pitt Shelton. ‘Until home values stabilize and delinquency trends stabilize, we’re going to continue to have this discussion: What are these losses are going to be?’”
(2) “Finally, the government itself has taken steps that make it more likely Fannie Mae and Freddie Mac will need its cash. The government has introduced several programs to protect debt issued by other institutions, such as banks. Fannie Mae and Freddie Mac lack this explicit federal guarantee and that has made their debt comparatively less attractive to investors, increasing what the companies have to pay to raise capital in private markets.”
(3) “Moreover, the decision by Treasury Secretary Henry M. Paulson Jr. to abandon the plan to buy the troubled mortgage-related assets from banks and other financial firms poses a problem for Fannie Mae and Freddie Mac. Not only do the companies lose the chance to sell any of these assets to the government, the announcement Wednesday that the program had been shelved caused the value of the assets to fall.”
A longer perspective on the difficulties presented by our present “version” of capitalism can be found in Capitalism 3.0 by Peter Barnes, who sees our economic system as much like a computer’s “operating system” and argues that its terms are subject to adjustment – ie design — depending on conditions and our desired outcomes. Barnes has a number of suggestions. See http://capitalism3.com/