To Conservatives and Liberals: It’s the Black Swan, Stupid!

House of Cards

Photo by: Perry Gerenday Photography

As I write this Washington Mutual had just collapsed–”the largest bank failure in American history”–and the bailout talks just ended in chaos. Swell.

I’m ignorant when it comes to the complexity of economics. But it seems to me that there are plenty of blame to go around: government, banks, and people who took loans they can’t afford. In short, we’re all in this deep shit together, whether we’re innocent or otherwise. Who says that the world is fair anyway? That’s why it irks me when people play the blame game just to prove that their ideology is better than the other.

Here’s a case in point: Some conservatives blame liberals for the current economic crisis.  See NYPost: House of Cards – Liberals Fueled Wall Street Woes.

HOW did America wind up in its worst financial crisis in decades? Sen. Barack Obama explained it this way last week: “When sub-prime-mortgage lending took a reckless and unsustainable turn, a patchwork of regulators systematically and deliberately eliminated the regulations protecting the American people.”

That’s exactly backward. Mortgage lending took that “reckless and unsustainable turn” because of regulation – regulation driven by liberals and progressives, not free-market “deregulators.”

Pushed hard by politicians and community activists, the regulators systematically and deliberately altered financially sound lending practices.

The mortgage market was humming along just fine when, in the late 1980s, progressives decided that it needed to be “fixed.” Their complaint: Some ethnic groups got approved for mortgages at lower rates than others. (read more)

Well, if you identify as a conservative then you might consider this article as “proof” that liberal/progressive ideology (i.e. multiculturalism, political correctness), rather than conservative ideology (i.e. less government regulation), is the root-cause of the subprime mortgage crisis. The NYPost article essentially puts the blame on Community Reinvestment Act (CRA) – the purpose of which “is to provide credit, including home ownership opportunities to underserved populations and commercial loans to small businesses.” Great! Here’s a proof that liberal ideology got us into this mess! Conservative ideology of less government regulation is not to be blamed! My ideology is better than yours! Booyah!

However, there is another side to this argument which essentially demolishes the above article. See American Prospect: Did Liberals Cause the Sub-Prime Crisis?

It’s telling that, amid all the recent recriminations, even lenders have not fingered CRA. That’s because CRA didn’t bring about the reckless lending at the heart of the crisis. Just as sub-prime lending was exploding, CRA was losing force and relevance. And the worst offenders, the independent mortgage companies, were never subject to CRA — or any federal regulator. Law didn’t make them lend. The profit motive did.

And that is not political correctness. It is correctness.

My take? Like I said, I’m ignorant with economic matters. Like most people I go by the opinion of experts, in this instance, economists, as well as journalists and politicians who explain the crisis in layman’s terms. Both articles have their conservative and liberal bias, respectively, but I think that the American Prospect article makes more sense. Indeed, CRA may have partially contributed to the economic crisis, as argued by Ron Paul. However, it seems to me that greed in Wall Street and less/more (depending on your conservative and liberal views) government regulation also played a major part in the subprime crisis, but it’s the banking system’s flawed statistical methods which is the bedrock of this mess.

In short, regardless of our conservative or liberal ideologies, the banking system is simply not equipped to handle Black Swans. See EDGE: The Fourth Quadrant: A Map of the Limits of Statistics by Nassim Nicholas Taleb.

The current subprime crisis has been doing wonders for the reception of any ideas about probability-driven claims in science, particularly in social science, economics, and “econometrics” (quantitative economics). Clearly, with current International Monetary Fund estimates of the costs of the 2007-2008 subprime crisis, the banking system seems to have lost more on risk taking (from the failures of quantitative risk management) than every penny banks ever earned taking risks. But it was easy to see from the past that the pilot did not have the qualifications to fly the plane and was using the wrong navigation tools: The same happened in 1983 with money center banks losing cumulatively every penny ever made, and in 1991-1992 when the Savings and Loans industry became history.

It appears that financial institutions earn money on transactions (say fees on your mother-in-law’s checking account) and lose everything taking risks they don’t understand. I want this to stop, and stop now—the current patching by the banking establishment worldwide is akin to using the same doctor to cure the patient when the doctor has a track record of systematically killing them. And this is not limited to banking—I generalize to an entire class of random variables that do not have the structure we think they have, in which we can be suckers. (read more)

Bottom line: Instead of arguing, defending, and attacking conservative and liberal ideologies, it’s more sane to go back to first principles and tackle the limits of the banking system. I’m certainly not qualified to do this. Heck, I don’t even look at my 401K. All I know is that I have a first-hand experience on the economic hardships we’re going through right now. And I consider myself lucky to have landed a job that pays the bills.

Playing the lemon-eating blame game won’t do us any good except deepen our ideological differences. I just hope that when I wake up tomorrow, there’s already an agreement on how to proceed with the $700 billion bailout.

P.S. Dear Barack Obama: I’d like to see Nassim Nicholas Taleb as one of your economic advisers when you become President. Dear John McCain: Enough politics. Enough excuses. I expect to see your “maverickness” in the Presidential debates.

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