Ashby’s Law and “Phase Four Souvlaki”

When I lived on Capitol Hill forty years ago, another odd-ball from the Marine Corps Reserve, Larry Feldman, and I frequented a certain Greek restaurant for souvlaki. Sometimes we had other things, but the souvlaki was great.

During the Nixon Administration, inflation got out of hand, and the President imposed Wage and Price Controls (always capitalized!). A 90 day freeze somehow became a thousand days of monkeying with wages and prices, known as Phases One through Four. Wikipedia will tell you more than you want to know, including: “The controls helped Nixon to re-election, but afterwards were seen to be a total failure; meat disappeared from grocery store shelves and Americans protested wage controls that didn’t match up to inflation.” And, “In these phases, the controls were applied almost entirely to the biggest corporations and labor unions, which were seen as having price-setting power. However, 93% of requested price increases were granted and seen as necessary to meet costs.”

My friend Larry and I had a phrase that captured the absurdity of Wage and Price Controls, at least as imposed by Nixon. We talked about “Phase Four Souvlaki,” which had gotten smaller and smaller. It will come as no surprise to you to learn that as prices for meat and sour cream went up, the size of the souvlaki serving went down, since its price was “frozen” by the wage and price controls. Duh!

I learned later that this is not only a lesson in feedback loops at the wholesale and retail levels, but also a great example of Ashby’s Law of Requisite Variety!
The government simply had no chance of enforcing its wage and price controls! How many inspectors do you think it would have taken to weigh portions at all the restaurants across America each day? You can’t get there from here.

Wage and Price Controls haven’t been tried across the United States since then, but I’ve no idea whether they’ve been forgotten or whether someone somewhere learned about Ashby’s Law.

Even though Ross Ashby was still in school when Prohibition in the United States ended, some observers of Prohibition (always capitalized) have observed the “Ashby’s Law” problem.

As noted in Wikipedia, “A total of 1,520 Federal Prohibition agents (police) were given the task of enforcing the law.” And also, “Many of Chicago’s most notorious gangsters, including Al Capone and his enemy Bugs Moran, made millions of dollars through illegal alcohol sales. By the end of the decade Capone controlled all 10,000 speakeasies in Chicago and ruled the bootlegging business from Canada to Florida.”

Fifteen hundred agents? Ten thousand speakeasies in Chicago alone? Gimme a break!

Oh, and did I mention “unintended consequences?” As John D. Rockefeller, Jr., said, “When Prohibition was introduced, I hoped that it would be widely supported by public opinion and the day would soon come when the evil effects of alcohol would be recognized. I have slowly and reluctantly come to believe that this has not been the result. Instead, drinking has generally increased; the speakeasy has replaced the saloon; a vast army of lawbreakers has appeared; many of our best citizens have openly ignored Prohibition; respect for the law has been greatly lessened; and crime has increased to a level never seen before.”

Are there lessons here for those that decide how governments tackle problems? That is, the designers of government?

WAPO: “Rain Forces Open to Shut Down Early”

This is a headline on the front page of a section of today’s Washington Post. Can you guess which section?

Reading this I thought of Paul Pangaro’s wonderfully insightful “Notes on the Role of Leadership and Language  in Regenerating Organizations,” what Paul calls his “Little Grey Book.”

Paul says that every organization creates its own language. This language facilitates common understanding within the organization, but it also creates barriers inhibiting understanding of the world outside, as well as understanding by the world outside.

Needless to say, the future is outside the organization. If your organization can’t “see” (understand) the road to the future, “you can’t get there from here.” Does General Motors ring a bell?

And the larger the organization, the less opportunity each individual has to interact with anyone outside the organization. Imagine marbles on a saucer vs marbles on a platter: what percent of the marbles touch the edge? And government has some of the biggest platters in the business!

When I worked in the Pentagon, we used to joke that the reason we used so many acronyms in conversation was that without them the workday would have been ten hours long, not eight. (Actually we said ten days not twelve; that’s another Pentagon joke: working a half-day meant only twelve hours!)

This insight of Pangaro’s is only one of a great many; you (or I!) could profitably spend many hours reading his work at We met around the meetings of the American Society for Cybernetics. At the annual conferences, one asked each friend, “What has become obvious to you since last we met?”

Paul Pangaro always had the best answers. He still does.

(BTW, the headline was from the sports section. “Open” is a golf tournament.)

No “Department of Alexis Agyepong-Glover” — sadly.

The Washington Post today reports that one social worker has been fired and two others disciplined for “mishandling” the case of Alexis Agyepong-Glover, 13 years old, whose adoptive mother is accused of abusing and murdering her. The details are horrifying.

The county supervisors have added a full TWO additional social workers! Be still my heart!

“Ledden (Director of Social Services) has also been meeting with county Police Chief Charlie T. Deane to discuss how their departments can better coordinate and share information, and he might ask the county to petition the General Assembly for less-restrictive laws governing what information can be shared across agencies in child abuse cases.” Duh!

GIVEN that budgets are tighter than ever, and social workers are always paid DIRT, we need some tools to make their lives both easier and more productive. And the clients need them to be able to do the jobs they signed up for.

My “Department of Mary Jones” on Facebook idea would be just such a loosely-coupled system – easy to read, easy to post, and two million Americans are already “trained” on it — at no cost to government. See those posts.

And cry me a river for Lexie.

Unintended Consequences of Food Stamps in rural Louisiana (gems from earlier postings)

From the first posting on this blog, excerpted from a paper I wrote in 1977:

“An example closer to home was the surprising preference of the local powers in some unreconstructed rural Southern counties for the food stamp program over the old commodities distribution program. Most people in the North thought the food stamps far more liberal and humane.

In 1968, while travelling in upstate Louisiana for the Office of Economic Opportunity, I found out that the food stamp program (a) enriched the local storekeepers, (b) permitted both the hiring of white clerks and the firing of Black warehousemen, and (c) was driving the poorest of the poor out of the state. They could not afford the minimum cost of the food stamps, and their source of commodities was shut off.

I dare say that few of these consequences were uppermost in the minds of the major sponsors of the food stamp legislation.”

Speed Limits for Wall Street

If Wall Street is going to run the economy into the ditch every once in a while, then government is going to have to impose speed limits or hire some more cops. The Administration’s plan is to hire more cops. I’m for more speed limits.
Even Alan Greenspan is in “a state of shocked disbelief” at the consequences of “the self-interest of lending institutions.”  So once again the debate is about the speed limits and the cops. We’re not hearing so much about the glories of the open road.

There are both theoretical and practical problems with just hiring some cops. There are several practical problems.  Some of the cops just hang around fruit stands eating the apples (see: Bernie Madoff and the SEC). Sometimes the word from headquarters is to spend more time polishing the patrol cars (see: Christopher Cox and the SEC). And sometimes budget cutbacks reduce the cops to invisibility (see: CPSC and Chinese toys).
The theoretical problems are far more serious. They stem from Ashby’s Law of Requisite Variety, a fundamental proposition in cybernetics and systems theory. Ashby’s law states that “only variety can absorb variety.” More simply stated, three basketball players will never be able to outscore five players. Just ain’t gonna happen.

Regulations and regulatory agencies are the cops in this story, and Ashby’s Law applies in both (1) space and (2) time. First, there are a lot more folks on Wall Street (read: the financial sector writ large) than regulators, and ‘twill be ever thus. The regulators can’t be everywhere.

Second, regulation as a ‘tool of government’ is effective only until the regulated evolve enough to evade the regulations. This happens quickly. In today’s world of instant information, we’ve even seen the financial markets evolve ahead of our imaginations. So today’s regulations can never prevent tomorrow’s problems. A recent Tom Toles’ cartoon captures this well.

This would be true even if we truly understood either (a) the financial system or (b) the governments’ interactions with it. Only a certified system dynamics simulation model would show we understand the financial system itself. And even though the Clinger-Cohen Act of 1996 mandated enterprise architecture for federal programs, there’s been no attempt to apply this form of systems analysis to the many and varied governmental agencies, taken together, that touch the financial system.

So that leaves “speed limits,” defined as any controls built into the system that don’t require cops (regulators) for enforcement.

All the attention has been on “executive pay caps” and whether these will destroy the motivation of the Masters of the Universe, and on and on. This is a wrong-headed approach.

Back to the highway analogy. Imposing executive pay caps is like putting a governor on a rental car driven by a teenager. It’s not his car, and he’s still out looking for thrills.

We need to have bankers act like a new father out driving with his baby daughter in a car seat in the back. We need them to have some ‘skin in the game.’ We need them to retain substantial personal liability so they act (drive) more cautiously. We need to add some fear; reducing greed alone won’t cut it.

Joe Nocera’s entrancing New York Times Magazine article, “Mismanaging Risk,” goes on for 7500 words about investors’ risks and firms’ risks but never imagines that risk might apply to the people running the firms.

Corporations are creations of governmental laws and regulations. So are partnerships, limited liability companies , and limited liability limited partnerships. It would not take “rocket surgery” to create and mandate a form of entity for firms capable of causing “systemic risk” that would retain personal liability for managers whose actions could put either their firms or the economy at risk.

Median annual household income
in America was $50,223 in 2007. I think someone gunning for one hundred times that should be willing to put his Manhattan apartment, his house in the Hamptons, and both yachts at risk until he’s been out of the game for, say, ten (10) years.

Give me my choice of three Harvard professors, throw in one from MIT, and I’ll have a solid draft for you in a weekend.

Let’s see some “skin in the game” on Wall Street

Letter to the Washington Post:

Max Stier (June 8th: “The Flow-Chart Fallacy”) is half right. We don’t need to reorganize and layer the regulatory communities around food safety and the financial system. We’ve had our Katrina on Wall Street. Building a bigger financial regulatory structure won’t prevent another dangerous recession, just as creating the Department of Homeland Security certainly didn’t help with hurricane recovery.

But improving the leadership of the regulatory community won’t help if a future Administration’s policy is to turn a blind eye to abuses, or if agency budgets are continually reduced. And useful measurement tools won’t correct the fundamental flaw of regulation: Regulations are great for controlling old problems, but they seldom if ever prevent new problems from emerging or control them when they do.

We need some fundamental changes to “the way the game is played” in capitalism, akin to those that restrained monopolies a century ago. Surely the maintaining the health of the financial system today is at least as important as restraining Standard Oil was then.

I have two suggestions for starters. First, I would limit the market share of any bank, hedge fund, etc., so that individual failures would not threaten the overall system. We’ve had banks get bigger, not smaller, since last year. And of course I’d reinstate Glass-Steagall (1933) in a Wall Street minute!

Second, I would mandate that large financial entities be licensed and managed as “limited liability partnerships” rather than corporations. (A hybrid form to include shareholders is not beyond the imagination of policy-makers and law school professors.)

Such an entity would require that the senior staff, those making more than, say, $1 million per year in salary and bonus combined, would be personally liable for any losses and any damages and remain so for a period of perhaps ten years after leaving the firm.

Rather than fight a losing battle over executive pay caps, I’d like to see the Masters of the Universe have some “skin in the game.” A lot of skin.

Drivin’ close to the mountain

One of my father’s favorite stories – meant to instruct as well as entertain – was about the Irish lord interviewing candidates for coach driver. He asked each, “And if the English were coming, and you had my family in the coach and had to hurry down the mountain, how close to the edge of the road would you drive?”

The first man said he’d drive as close as a yard to the drop-off below. The second man, wanting the job, said he’d drive to within a foot. The third man said, “Sure, and I’d be drivin’ as close to the mountain side of the road as I could, yr Lordship!”

The third man got the job.

This came to mind yesterday when listening to Marketplace on NPR. Tess Vigeland said, “Three hundred and forty-five thousand people lost their jobs last month. Now the pace of layoffs is slowing, but the Labor Department reports the unemployment rate now stands at 9.4 percent. Want to hear the scary part? Well remember those bank stress tests? The unemployment rate used in their so-called “Worst Case Scenario” was a mere 8.9 percent. Oops.”

That raised a flag for me, because for months unemployment has been predicted to rise to over 10 percent in 2009.

Then I read a story on Bloomberg News, Bank Profits From Accounting Rules Masking Looming Loan Losses, that included the following:

“Treasury Secretary Timothy Geithner, after “stress testing” 19 banks on their ability to withstand a worsening economy, declared in early May that Americans can be confident in the banks’ stability and resilience. Wells Fargo & Co. and Morgan Stanley were among banks raising $43 billion in new capital since then through share sales…

“… Janet Tavakoli, president of Tavakoli Structured Finance Inc. in Chicago, says the government stress scenarios underestimate how bad the economy may get…

“The Federal Reserve, which designed the stress tests, used a 21 percent to 28 percent loss rate for subprime mortgages as a worst-case assumption. Already, almost 40 percent of such loans are 30 days or more overdue, according to Tavakoli, who is the author of three primers on structured debt. Defaults might reach 55 percent, she predicts.”

The last “stress test” that I had involved a treadmill and a lot of heavy breathing. I was wired up with a heart monitor and under the close supervision of several folks in white coats.

It’s beginning to look like the “stress tests” those nineteen banks passed were more like a walk in the park!

How can the government claim it’s measured something – say the safety of banks – if the yardstick isn’t both (a) clearly marked and (b) open to inspection?

Almost as troubling but more obscure are some of the rules of the (banking) game that the Feds have changed recently. I remember the discussion of “mark-to-market,” but some are far more arcane. The Bloomberg article includes this:

“Along with that change [mark-to-market], FASB also let companies recognize losses on the value of some debt securities on their balance sheets without counting the writedowns against earnings. If banks plan to hold the debt until maturity, they can avoid hurting the bottom line.

“Another $2.7 billion before taxes came from an accounting rule that lets a company record income when the value of its own debt falls. That reflects the possibility a company could buy back bonds at a discount, generating a profit. In reality, when a bank can’t fund such a transaction, the gain is an accounting quirk, Weiss says.”

Such rules raise two ‘governance’ issues. First, and foremost, what are the possible unintended consequences of hurried rulemaking? Second, what is the likelihood that such rules, of obvious benefit to the industry, will ever be rescinded?

Aren’t we getting closer and closer to the edge of the mountain?

Bob Gates is not alone!

In last week’s hagiographic piece on Secretary of Defense Robert Gates, Joe Klein of TIME says “After a quietly impressive career in government that has spanned more than 30 mostly Republican years, Robert Gates is suddenly seeming almost, well, charismatic. He reeks authority. He is, according to several sources, the most respected voice in National Security Council debates. The President is said to love his unadorned manner. Much of which is attributable to the fact that, in the self-proclaimed twilight of his public career, Gates has emerged as that most exotic of Washington species — the bureaucrat unbound, candid and fearless. He tells members of Congress what he really thinks about their pet programs. He upends Pentagon priorities, demotes the military-industrial hardware pipeline and promotes the immediate needs of the troops on the front line.”

Bob Gates is really good at what he does. The Klein piece goes on, “Gates originally had planned to retire after a year or so, but he seems to have settled in, found a level of comfort and influence with the Obama Democrats that he never quite expected. ‘I don’t do maintenance,’ Gates told me. ‘I would never do a job just to sustain the status quo. I like to go into an institution that’s already good and do everything I can to make it better.’”

What Klein, and too much of Washington and America won’t acknowledge, however, is that Bob Gates is the product of a system that promotes the best talent based on merit, and he’s hardly alone.

Let me give you some numbers. The Federal civil service has about two million members. (In 1992 there were 2.169 million. Vice President Gore’s National Performance Review lowered the total to 1.814 by 2000, and in 2008 it was back up a bit to 1.875.) The Senior Executive Service – the equivalent to Generals and Admirals in the military – has about 6,000 career members (I’m not counting the political appointees). That’s a lot of people, even though it’s only three tenths of one percent (0.003%) – and all were chosen because of their accomplishments, not their acquaintances.

There’s another group that’s even more exclusive: the recipients of the Distinguished Rank Awards from within the Senior Executive Service. Only 60 of these awards are given out annually. Each recipient gets a nice check, a framed certificate, a photo-op with the President, and (at least the year I got one) an invitation for two to a lovely formal dinner at the State Department. Note that only 0.00003 percent of Federal government workers get this award each year. That’s the equivalent of only 9,000 Americans nationwide.

You might think that incoming cabinet secretaries and other agency heads would ask for the names of these folks and get to know them, individually or in a group, when they come in and take over. They might have some good advice. After all, we “know the territory.

Never heard of that happening, though. I guess we’re too exotic.