Saturday, November 08, 2008


For the last two decades, it was a Schumpeterian world, as workers were told to have patience when their trusted social structures collapsed, and it was promised that new and better forms of civil society would emerge.

Now, of course, we have seen the collapse of big business, in as spectacular a fashion as big government collapsed in the seventies. And, of course, big business has sought to revive big government to protect it from the market's judgment of its failure.

But the real failure of our financial system came from extreme centralization and inadequate diversification. On a superficial level the financial system failed because the quality of free research available from Wall Street -- the foundational underpinning of the Efficient Market Hypothesis -- underwent a fundamental change when analyst compensation was reduced in the wake of Eliot Spitzer's indictments, while analyst compensation was increased at hedge funds. Once the top tier of analysts moved to hedge funds, the mid-level analysts at the ratings agencies were -- definitionally -- the people who could not get top-tier hedge fund jobs, and they were strangely in the dark while plying their trade.

But the real problem is an absence of diversity of opinion -- the collective group-think that descended on financial institutions where models estimated risk two three decimal places, but nobody bothered estimating the risk that the models were wrong (which is not to say that there weren't plenty of voces clamantes in desertas, but just that such people were effectively isolated from power). Those who felt in their gut that the models were wrong, were told that they didn't have the intelligence to deserve the high compensation that was a natural consequence of feeling in their gut that the models were right.

But this ultimately refutes the classroom model for stratifying intelligence and shows a sharp critique of Goldman/Harvard synthesis. By drawing our social elite from people who have the unique ability not to upset their social superiors -- people who receive Rotary Scholarships, get positive recommendation from High School teachers, learn to flatter the egos of the establishment figures at our institutions of higher learning -- we create an environment inside the higher echelons of corporate culture that is uniquely prone to groupthink, since these are the very people who were best able to articulate the hidden views of their teachers when they were in school. The result is, of course, that when an educational pedigree is the prerequisite for filling a social role, the people who fill that social role usually have a special gift for intellectual mimicry, and the absence of core values that is highly correlated with the ability to simultaneously please a variety of divergent professors gets caught in the amplification chamber of the modern american corporation, causing a lack of doubt in the generalized consensus.

Which is not to say that the highest reaches of American society should be staffed by pot-smoking drop-outs, though it is hard to imagine a bunch of stoners doing a much worse job, but rather to say that the failure of the financial system is, in fact, an indictment of the entire social structure that has emerged in the previous half-century. People who are thoroughly invested in that social structure can only imagine preserving it, and the means by which a highly centralized, systematically unintelligent social organization is to be preserved will only increase the imbalanced weight of the social structure when it is time for it to collapse, while forestalling the inevitable emergence of a more dynamic social structure.

Which brings us back to Schumpeter. Capitalism is a dynamic system, but humans are terrified little mice, who scurry to the safety of their holes at the first hint of change. For the longest time, so-called capitalists derided the working classes resistance to change, but when the capitalists are asked to do the very thing that their professed allegiance to their form of social organization would ask of them, they balk, and become the biggest and loudest whiners of them all. Schumpeter is usually seen as a reactionary, chiding the workers for their unionized resistance to progress, but the simple fact is that the real resistance to progress comes from those with the greatest stake in preserving the collapsing system -- namely the members of the Harvard/Goldman elite, and it will be interesting to see to what degree Obama is committed to preserving a system that has benefited most of his friends.

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