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January 31, 2009

What does the recession say about us

Here is the online video of a DLD conference in which Daniel Kahnemann, a psychologist and Nassim Taleb, an economist,  talk about what’s going on right now with the recession and what led to it. This conference is very interesting and informative, to say the least. In this post I would like to ponder a little on a few of the ideas presented there.

One of the ideas presented there was that people ignore risks because they prefer not to think about them, it makes them feel safer if they ignore the threats; and if they have statistics that show how a risk is very small, they will believe the statistics although this kind of data is irrelevant for unexpected disasters. What professor Taleb calls a “black swan” is an event very rare that you can not possibly predict it. Yet black swans come and go, rare events happen, yet we are never prepared for them. Our current statistical methods do not take them into account because we have no theoretical model for such things – therefore the black swans do not exist. It is some sort of wishful thinking, we hope that if we close our eyes the black swans will never come because if we don’t see them, the disasters won’t notice us either.

Current economical methods dwell in the normal everyday events and can predict them with a high degree of accuracy. But in face of an imminent disaster this mainstream economy is helpless. It cannot predict these rare events, it cannot handle them, it cannot stop them from repeating in let’s say 20 years. After this crisis will be over people will still predict events using the old models and nothing will have changed, unless we do something to change the system right now.

An interesting philosophical problem is how the USA government chose to handle the financial crisis. As we all know, a few banks led to this disaster. The banks were privately owned and acted as if they were on a free market, their risks were their own to take, the benefits were theirs. Now as the banks started to collapse, suddenly the risk was shared with the State, and banks acted as if the State had a duty to bail them out.  In other words, what we win is ours (free market, private company) what we lose is everybody’s concern (State-controlled market, nationalized company). This is a dual thinking, very strange because it combines two economical models which shouldn’t be merged like this.

Why should taxpayers pay the debts of a privately owned firm? What is the logic in this? The main concern was of course that people would lose their money which they had previously deposited in a bank account.  When the banks took high risks and indebted themselves, they never thought about the concerns of those people who trusted them with their lifetime savings. But the State has to think about these sorts of things, because it’s the State’s duty to be paternalist and take care of everybody. But then why doesn’t the State save every little firm that goes bankrupt? Let’s say a small bicycle company  has 3 employees and it goes bankrupt.  Why doesn’t the State jump in to save the firm and therefore to save 3 people form unemployment? Because 3 unemployed people would not be a disaster for the national economy, because we have a free market, fair competition, and they have to find work themselves. But let’s just imagine that the small bicycle company had made huge investments in stocks and that now, with its bankruptcy, the stock exchange will go down because of one man who invested that which he did not have. He took foolish risks and now the economy will suffer. Now the State has sufficient reason to bail the company out. In the first scenario, the owner of the company was a reasonable man and he lost, in the second scenario he was a fool who took absurd risks and won.

Things should not be like this. If we take the risks of someone upon us, we should benefit from the profits also, and vice versa. As long as the banks never shared their profit with the State and its taxpayers, the banks should not benefit from State-insurance. The people who took risky decisions in those banks were always in a win-win situation and therefore we couldn’t expect any responsibility from them. Before the crisis they had huge profits. After the crisis they used the money received from the state to pay themselves bonuses and high salaries and then took further risks with their investments. Whatever they do they know that someone will bail them out no matter what because it’s people’s money they are toying with. If they go bankrupt, so does the whole country and the State will do whatever it can so it doesn’t come to this.

Now their position is very rational and profit oriented. What they do is rational although  not ethical, and they cannot be blamed for irrationality while gambling other people’s money. We shouldn’t start an absurd quest for angels that will replace the corrupt executives;  if we had been in their shoes maybe we would have made the same decisions. What philosophers and economists have to do right now is to find an economical system that will not allow people to get in such positions that favors total irresponsibility. That is, back to Popper, to find such a system that will work even if the worse people would become its leaders  – only this time we are talking about an economical system.

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