Tuesday, October 27, 2009

A Tragedy in the Commons

Amongst ecologists, the tragedy of the commons is a well-known phenomenon that demonstrates how the rational pursuit of self-interest can lead to an irrational result, the collapse of a shared limited resource. The standard example is the case of a sheep herder who brings to the common grazing grounds some extra sheep to feed. As long as everyone else respects their quotas, he experiences the gain from feeding his extra sheep whereas the rest of the herders share the loss. All is fine and well until other herders begin to adopt the same strategy. If enough herders do so, the grazing of the sheep will exceed the capacity of the commons to regenerate itself, thereby diminishing the feed available to all. Everyone loses.

In the House of Commons, we have recently witnessed a similar problem in sustaining a collective action that would bring benefits that would be distributed widely. In this case, it is the adoption of Bill C-311, otherwise known as the Climate Change Accountability Act. If adopted, the Bill has already passed two readings, it would commit Canada to reducing its green house gas emissions 25% below 1990 levels by 2020 and 80% below 1990 levels by 2050. This is the scale of the required reductions that Canada and other developed countries must undertake if catastrophic climate change is to be averted.

Unfortunately, a motion was introduced to extend the time the Bill would pass in committee thereby preventing the adoption of the Act before the upcoming global summit in Copenhagen, where the global community would gather to discuss and hopefully come up with a plan to replace the Kyoto Accord. Previously, the three parties in opposition voted together in support of Bill C-311, but this time around it was the Liberals who voted with the government to scuttle the attempt to have Canada arrive at an international summit on climate change with something to bring to the table.

In regard to Kyoto, Jeffery Simpson sums up Canada’s pitiful performance in a recent article: as for Canada, its record on reducing emissions is recognized internationally to have disgraced the country's good name. It broke all its promises at Kyoto. Domestic emissions continue to rise.

Disgraceful, shameful, and uncaring are all words associated with Canada’s international reputation. Maybe its time to tear off the maple leaf from our back packs before the Olympic craze takes over the land.

Clearly, the Liberals and NDP are caught up in the perpetual electoral campaign that has seized Canadian politics. Together, with the support of the Bloc, they could have pushed this bill through, or if they felt that the long-term well being of the planet mattered enough, they could have brought down the Conservative-led Government. Yet, for all their platitudes about the importance of addressing the problem of climate change, each party remains trapped in its Quixotic quest for a single-party majority government. Once again, everyone loses.

The only bright spot to this sad story is the group of young adults who seized the moment and disrupted Parliament from the gallery during Question Period and denounced the government’s inertia with their shouting of slogans. They were of course expelled from Parliament, but it was very refreshing to see Canadian youth manifest their disapproval and refuse to join the swelled ranks of their smug and complacent Parliamentarians.

Tuesday, October 20, 2009

The Constitutional Kerfuffle Masks the Democratic Divide

This week Canadian Prime Minister Stephen Harper referred the question of whether the federal government has the power to create a national securities regulator to the Supreme Court of Canada. Three provinces (Quebec, Alberta, and Manitoba) oppose the creation of a federal regulator.

Talk about being trapped in a dysfunctional political discourse. For more than 140 years we have been wrangling over the question ofprovincial/federal jurisdiction. What gets lost in this debate is whether the members of the public are sufficiently protected from the unscrupulous trading practices of the financial industry.

It seems to me that the more pertinent question is would it be in the best interest of the public to create a pan-Canadian regulatory agency given that Parliament is ruled by successive political oligarchies. Political power in this country is largely determined by the ability to appeal and solicit donations from the investor class. Within this framework, we would expect that such a regulatory body would be more favourable to the interests of the financial industry at the expense of the general public.

Look at the recent US experience. Effective lobbying by the financial industry led to the repeal of the Glass-Steagall Act. The repeal enabled commercial lenders such as Citigroup, which was in 1999 the largest US bank by assets, to underwrite and trade instruments such as mortgage-backed securities and collateralized debt obligations. A year later, the Commodity Futures Modernization Act of 2000 was adopted, which exempted the exchange of financial derivatives from federal regulation.

Everything was then in place to produce an economic meltdown that enriched those in the financial industry beyond belief and produced unimaginable collateral economic damage for the bulk of the population: 8 million lost jobs, almost 1 million home foreclosures in the third quarter of 2009 alone, pension plans reduced by 30% and more, and untold trillions in accumulated public debt foisted on the present and future generations.

Here in Canada, our democratic institutions are not sufficiently democratic to prevent a similar rewriting of the financial regulatory practices that would enrich an extremely small but extremely powerful elite at the expense of the vast majority of Canadians. Neither the Conservatives nor the Liberals can muster the support of more than 25% of the electorate. Yet, the power of the majority can be exercised under the threat of sending the electorate back into a general election, something that the Economist referred to as Canada's perpetual electoral campaign.

In principle, the creation of a federal regulator could be very beneficial if it exercised its power so that the wealth generated from the real economy was distributed in a more equitable fashion and prevented the buccaneers of high finance from siphoning off this wealth through the churn of dubious financial transactions.

If there is one lesson that we should draw from the US experience is that the finance industry can capture the regulatory function. Evidently, the counterbalance to unacceptable levels of systemic risk engendered by the greed of a few is the effective representation of the many. However, the British parliamentary system substitutes the effective representation of the majority with the over-representation ofa well-heeled minority through the systemic distortion of the electoral results. Without qualitative change to our electoral system, there remains a distinct possibility that any pan-Canadian regulator would escape democratic censure.

To move forward with the proposal, democratic reform must precede the creation of the new financial institution. Questions of provincial jurisdiction are anachronistic because of the way the exchange of financial securities no longer respects territorial limits. Securities are now traded 24 hours a day in a global market.

Finally, as a resident of Quebec I can quite comfortably say that the claim that the creation of a federal regulator is an affront to Quebec sovereignty is laughable given the recent scandals in Quebec involving Vincent Lacroix and Earl Jones, two financiers that bilked their clients of millions, and the recent performance of the Caisse de dépôt et placement du Québec, the fiduciary responsible for the management of many of the province's pension plans, which saw a reduction in value of 24% of its investment portfolio (approximately $40 billion) in 2008 and a failure to generate any returns for the first six months of 2009. Having failed miserably to meet even the most modest of performance requirements, the Quebec government has little in the way of legitimacy in the eyes of its citizens as the a priori regulator of the financial industry within Quebec.

Sunday, October 11, 2009

In the Land of the Cannibals, the Ponzi Economy Rules

We are not used to thinking about our own political economy as one that cannibalizes its basic supporting subsystems in order to generate the greatest short-term profits possible for a wealthy elite. I know that some environmentalists would disagree. They would respond that they have been engaged in a struggle for decades against a political class that would expand economic production until every tree was logged, every lake and river left polluted, an atmosphere rendered unbreathable, and our topsoil turned into dust.

Tree huggers, what do they know? Well, they were bang on in identifying the self destructive nature of free market capitalism. They just didn’t predict that the insatiable appetite for profits would begin to feed off of the very means of production that generated the initial capital that the Lords of Wall Street successfully looted, multiplied, and subsequently ran off with, ravaging the US economy so that if it were a landscape, it would resemble the remains of a clear cut forest.

Presently, we are led to believe that the economy is this large, somewhat incomprehensible, singular entity. Most of our politicians try to pass themselves off as competent stewards of THE ECONOMY. In fact, we would do much better to think of THE ECONOMY as being composed of three mutually interdependent economies: the primary economy, which consists of the natural resources and the freely given human labour that sustains human society; the real economy, which is the sector of THE ECONOMY devoted to the production of goods and services with real added value; and the speculative economy in which money multiplies as a result of a series of financial transactions.

Essentially, the primary economy gives birth to the real economy, which in turn gives birth to the speculative economy. It should be obvious that if the quality of the primary economy is led to degrade sufficiently, continued activity in the other two economies will cease. This is, in a nutshell, the economic argument for addressing climate change former World Bank chief economist Lord Nicholas Stern makes in the Stern Review. If we don’t begin to act immediately, the economic costs resulting from not acting or an undue delay taking action will far outweigh the cost of the investments. Some would say it is already too late, and we will scorch the earth and leave the planet inhospitable for humans for hundreds of thousands of years.

What is relatively new is that with the near collapse of the global financial system and the Great Global Recession that ensued, it has become evident that the unfettered activities in the speculative economy have been catastrophic for the activities in the real economy. In the United States alone 8 million jobs have disappeared since December 2007, and the US government has been forced to assume trillions of dollars in debt to ward off being plunged into another Great Depression. What the stewards of the free market failed to realize is that those who were raking in billions as a result of their trades in the speculative economy were more than willing to sacrifice the well-being of those who toiled in the real economy because the scale of the profits were exponentially greater than what could be made by making money the old fashion way, earning it.

To understand how the Great Global Recession came into being, we must give proper consideration to key developments concerning economic policy during the Clinton–Bush years. In particular, there was a significant shift in the importance accorded to the speculative economy, and a decision made not to regulate the exchange of financial derivatives.

During the nineties, a seminal article, Securities: The New World Wealth Machine, appeared in the periodical Foreign Policy, which effectively explained how financial markets could become the most powerful generator of wealth. In what appears to be a classic example of putting the cart before the horse, the author articulates what would become the dominant economic strategy in the U.S:

Historically, manufacturing, exporting, and direct investment produced prosperity through income creation. Wealth was created when a portion of income was diverted from consumption into investment in buildings, machinery and technological change. Societies accumulated wealth slowly over generations. Now, many societies, and indeed the entire world, have learned how to create wealth directly. The new approach requires that a state find ways to increase the market value of its stock of productive assets. Several countries have successfully directed their economic policies toward that goal, achieving and sustaining faster growth rates than were once thought possible...

an economic policy that aims to achieve growth by wealth creation therefore does not attempt to increase the production of goods and services, except as a secondary objective.

This represents a historical shift in thinking about the economy. Evidently, there is a reversal of economic priorities in regard to the creation of wealth, in particular, a shift away from the production of tangible goods and services in the real economy to the manipulation of financial assets in the speculative economy. In other words, why go through the painfully slow way of creating wealth through the real economy when unimagined riches (for the few) can be obtained by shuffling financial securities.

Importantly, not only is there a big disconnect between a sustainable future and the desire for immediate reward, but, as well, between the well being of a political and financial elite and the rest of the population. At least, within the real economy even though the benefits are distributed disproportionally, there exists a common interest between capital and labor in that direct investment leads to the creation of jobs. In the speculative economy, however, the so called creation of wealth is little more than a transfer of wealth from those who toil outside of the financial sector to those who work within it and the clients that they serve.

In order to bring about the realization of the New World Wealth Machine, an obscure but critical piece of federal legislation called the Commodity Futures Modernization Act of 2000 needed to be introduced. It not only removed derivatives and credit default swaps from the purview of federal regulation, it gave Wall Street immunity from state gambling laws and legalizing activity that had been banned for most of the 20th century.

Interestingly enough, the legislation was never debated in either the Senate or Congress and was adopted unanimously on the last vote of the last day of the lame duck 106th Congress, between the election and inauguration of George W. Bush.

Once the legal impediments had been removed, Wall Street began to put into practice the irrational belief that great wealth could be created by convincing those with limited means to assume levels of debt they could not possibly service, transferring the fiscal responsibility of the debt to third parties and then betting on the outcomes. Indeed, this is the unregulated world of subprime mortgages, collateralized debt obligations and credit default swaps, which has turned out to be perhaps the greatest Ponzi scheme ever undertaken.

This is the way the scam worked. During the recent real estate bubble in the United States, people were lured into buying houses with surreal financial terms (the subprime mortgage): little or no down payment and a mortgage with a low initial interest rate which would readjust to a higher rate at a later date. Imbued with the expectation that real estate values would continue to rise, people were led to believe that they could simply sell their house at a tidy profit if they were subsequently unable to meet their financial obligations when the higher interest rate kicked in. Knowing full well that many of these mortgages would be subject to default if the American real estate market began to level off (more so, if values began to fall) the financial securities industry buried these suspicious debt obligations within larger and more complex securities (collateralized debt obligation) and sold them as AAA financial products on the global financial markets. To make matters worse, one could take out an apparent insurance policy (credit default swap) on the likelihood that a party would default on its debt obligations, and even worse, such a policy could be bought without even being party to the debt, in other words, a side bet, which explains why it was necessary to gain immunity from state gambling laws. Moreover, the marketing of these derivates as a type of insurance was fraudulent since no monies were set aside from which payments could be made in case of default on a debt obligation.

It doesn’t take much to realize that this set up is nothing less than an elaborate house of cards that will begin to collapse once the subprime mortgages surpass the accepted default rate. Once this occurs, a domino effect takes over, where one default triggers another and where no one wants to be holding the toxic assets. As should be expected, the one ultimately holding the bag is the tax payer because, after all that is said and done, it’s his job or his pension that is eventually imperiled once the decline in asset prices impacts upon the real economy, and it will be his tax dollars that is called upon in order to prop up the financial system.

Without question there was an absence of effective regulation of the financial markets. In the worst case, the Securities and Exchange Commission failed to intervene in the New York financier Bernard Madoff’s elaborate scheme that bilked friends, clients and charitable foundations of approximately $50 billion despite having been informed of the gross irregularities concerning his affairs. The failure to do so has been often cited as the reluctance of regulatory officials to investigate suspected criminal behavior by those with whom they might do business after their stint at the regulatory agency is over. After all, time spent working for the government can often be parlayed into future career gains in the private sector as a result of increased familiarity with the regulatory mechanisms.

With regard to a much more disturbing phenomenon, the bond rating agencies decision to award AAA status to collateral debt obligations tainted with subprime mortgages seems to be a case of the refusal to kill the goose which lays the golden eggs. There is a flagrant conflict of interest when financial institutions have their quality of their financial products evaluated by agencies that are funded by the said institutions. Moreover, there was simply too much money to be made to take the time necessary to evaluate the risk. For example, in 2007 the top fifty individual hedge fund managers earned $29 billion. Their average income was twelve thousand times the income of the typical American family.

Finally, the investment climate allowed private equity firms to engage in leveraged buyouts of successful companies that operate in the real economy in which the real wealth of the company was sucked out and replaced with mountains of debt, often forcing the cannibalized company into bankruptcy, leaving the bondholders not holding the appropriate credit default swaps, creditors, and of course the workers in the lurch.

In the most telling example, the iconic manufacturer the Simmons Bedding Company was flipped from one private equity firm to another, generating millions of dollars of profit in the process and leaving behind an accumulated debt that grew from $164 million in 1991 to $1.3 billion in 2009. According to analysts at Standard & Poor’s, more than half of the roughly 220 companies that have defaulted on their debt in some form this year were either owned at one time or are still controlled by private equity firms.

With respect to how the financiers of the speculative economy have behaved towards those who gain their livelihood from the real economy, it is similar in kind to the way the proponents of wealth creation through the real economy behaved to those whose livelihood depended on the health of the primary economy. In both instances, there was a pathological fixation on wealth extraction with little thought and no remorse for the damage left behind.

If we are to have a sustainable future and be stewards of THE ECONOMY, we will need to reverse the direction of the cash flow. Monies gained from the speculative economy need to flow back into the real economy in such a way as to re-establish the health of the primary economy. Faced with the possibility of catastrophic climate change, this is the biggest and most important challenge facing humanity today.

Thursday, October 1, 2009

It's the Climate Stupid

We are a culture that has been denied, or has passively given up, the linguistic and intellectual tools to cope with complexity, to separate illusion from reality.

Today cinematic, political, and journalistic celebrities distract us with personal foibles and scandals. They create our public mythology. Acting, politics, and sports have become, as they were in Nero’s age, interchangeable. In an age of images and entertainment, in an age of instant emotional gratification, we neither seek nor want honesty or reality. Reality is complicated. Reality is boring. We are incapable or unwilling to handle its confusion.

Chris Hedges, Empire of Illusion: The End of Literacy and the Triumph of Spectacle.

There are less than 70 days to go to the Copenhagen Conference, perhaps humanity’s last chance to come up with a viable solution to avoid catastrophic climate change. Yesterday, the US Senate made public its plan to cut green house gas emissions by 20% by 2020, using 2005 as a baseline. In the UK, British Prime Minister, Gordon Brown, announced his intention of making available $100 billion to help under-developed countries reduce their emissions.

In Canada, we are treated to the Denis Codere show. This week the nation focused its attention on the loose-cannon antics of the Liberals former Quebec Lieutenant who had resigned, claiming that he had lost the moral authority to do his job, and, what the Quebec media loves to hear, his claim that the Liberal Party is being run out of Toronto at the expense of Liberals in Montreal.

Morevover, instead of being present in Parliament to cast his vote on a vote of non-confidence that could bring down the Stephen Harper led Conservative government, he opted to miss the crucial vote in order to attend the taping of Tout le Monde en Parle, the most popular celebrity television talk show in Quebec that has a regular audience of Super Bowl proportions.

Likewise, the most popular newspaper in Montreal publishes on its front page the results of a poll which shows how the Liberals are experiencing, according the head-line, a brutal drop in the polls.

It must have been a boring week. Never mind the economy has tanked. Forget that negotiations leading up to Copenhagen have stalled and Canadian politicians, being in a state of perpetual election, have absolutely nothing to bring to the table.

Instead, we should focus out attention of the personal narrative of Michael Ignatieff, betrayed by his lieutenant and facing comparisons to his weak predecessor at the helm of the party. How will he manage? Will the Conservatives take advantage of his perceived weakness and call an election, hoping to find that elusive majority? What will happen to little Denis? Will he keep his seat or will he, like the former leader of the opposition in Quebec's National Assembly, Mario Dumont, get his own television program?

Essentially, we are being treated to what Benjamin DeMott calls “junk politics.” It does not demand justice or the reparation of rights. It seeks to divert attention away that which is important, and the result is that nothing changes—“meaning zero interruption in the processes and practices that strengthen existing, interlocking systems of socioeconomic advantage.”

So what if we don’t act to make the essential changes to the way we live and we scorch the planet in the process. Pity those passengers of the Titanic that only had an orchestra to listen to while the ship was sinking—we can watch our own disaster unfold with the brilliance of HD.