Nova's Been Misbehaving

I just watched a horrifically bad episode of Nova titled "Mind Over Money."

The thesis of the piece is that the financial meltdown disproved something they labeled "rationalist economics" and proved Keynesian theory and behavioralism.

The program begins by projecting irrational absurdities on rationalism. For example they assert that rationalism demands that rational person would never pay a penny over the real price of a good.

Nova then proves that the irrational absurdities that they project on their enemy "rational economics" leads to irrational absurdities.

Guess what? most irrational absurdities lead to more irrational absurdities. Straw men are made of straw.

Nova pointed out that folks in the Chicago School of Economics spend a lot of time analyzing mathematics models of trading behavior. Nova then made the bold claim that these mathematical models of trading behavior are the beating heart of the "rationalist school" of economics.

They completely failed to acknowledge that the emphasis on mathematical models of behavior were developed by behaviorists and were central to Keynesian economics.

The claim of the show is that the rationalist theory of economics boils things down to a set of equations that are supposed to always seek equilibrium.

They then go on to assert that the deeper thinking behaviorlists have a more holistic approach to economics that examines the reasons people trade the way they do.

I wanted to jump into the screen. Grab the idiot announcer by the scruff of the collar and bang his head against historical fact.

A truly "rationalist economics" would make the rationality of the individual the central focus of economics. A rationalist approach to economics would examine the reasons for individual behavior.

It is behavioralism that makes the mathematical model of trading behavior the central focus.

The propagandists at Nova turned the theories into their opposite.

Now, it is of historical interest that the Chicago School of Economics adopted the methodology of behaviorism.

My understanding is that the founders of Chicago School of Economics adopted the methodology of behavioralism largely because the theory of economics a half century ago was so thoroughly dominated by the Keynesian school that one had to include mathematical formula and behavioral models to get published.

The Austrian School of Economics, which is much closer to a truly rationalist approach to economics, disparages the Chicago School for its addiction to mathematical models.

Interestingly, Austrian economics seems to be a lot more in tune with business cycles and financial bubbles than those schools hypnotized by mathematical models. Adherents of the Austrian School of Economics were the first to scream about the likelihood of a major economic collapse.

I am sad that Nova produced such a poor quality show on the economic crisis.

The vary fact that financial institutions are and schools of economics are so fixated on mathematical models of behavior indicate that behaviorialism might be one of the root causes of the economic collapse.

I think it would be worthwhile to examine a truly rationalist approach to economics would work. As rationality is about reason, such a theory would make reason, not mathematical models, the central focus of study.

I find it unlikely that an economic system that made the rationality of the individual its focus would have the bizarre mix of short selling, insurance pools and derivatives that define our current economy.

The bizarre financial system that we have today is clearly evolved from the behaviorist approach to social science.

The Fine Line between Regulation and Manipulation

Thesis: Tools designed to regulate the economy can be used to manipulate the economy.

DeepCapture is critical of Paulson and Goldman Sachs. The lead in to the story states:

The Goldman CDO scandal and other evidence suggests that the U.S. economy was set up for a fall by market manipulating hedge funds.

The gas price chart at the the bottom of this post (from GasBuddy.com) shows a huge increase in gas prices in 2008 followed by a crash ... a sign of manipulation.

For several years, DeepCapture has documented odd stock behavior involving naked short selling. I began following short interest on several stocks and agree that the short selling complicates the process of assessing stock prices on corporate performance.

With these observations in mind, I thought I would parse the difference between regulation and manipulation.

This is not an easy task as the term "regulation" appears to have many meanings. In one sense, it means making things regular. For example, electrical sockets are regular. Because they have a standard design (are regular) we can plug a variety of appliances into any given socket. The electrical socket for my computer predates the PC revolution.

Some people use regulation as a synonym for law.

In the financial world, the word takes on a many different meanings. For example, insurance is used to regulate risk. One pays a regular premium each month to cover irregular health expenses.

Insurance companies are primary investors in our economy. They've applied their thinking about risk to other equities and devised a large number of tools to regulate risk in their investments.

For example, the Mortgage Back Securities that collapsed in the financial meltdown were designed to regulate exposure to individual mortgages. A bank will lend money on a mortgage. The repayment of the loan with interest is a nice regular source of money. If an individual defaults on a loan, the bank has to take a huge charge and lose the regular income. They often have to take this loss in a single quarter.

The system of mortgage backed securities, run by Freddie Mac and Fannie Mae, allow banks to bundle up mortgages into pools. This helps regulate the risk of individual loan defaults.

Credit Default Swaps and the Government Backed Re-insurance were designed to further regulate exposure to risks.

Short selling is often justified with claims that short selling provides liquidity for stores.

The whole Federal Reserve system was designed to help regulate the economy with tools that increased and decreased the money supply.

As I look at this complex set of tools used to regulate finances and the economy, I realized that the same tools can be used to manipulate the economy.

When the tools designed to "regulate" the economy get in the wrong hands, they can as easily be used to create financial destruction.

One might even go as far as to define "regulation" as "manipulation of the economy with the public good in mind."

For example, short selling, which can provide liquidity when a stock is hot, can also be used to destroy liquidity when the stock is in trouble.

Insurance, which regulates risk in normal times, can be used to temporarily hide underlying faults within a market...creating a systemic fault in the economy.

Now, what appears to have happened during the Bush Administration is that the financial world kept all the tools designed to regulate the economy going full bore. These tools generated false profits for financial firms but created a systemic risk for the world economy.

DeepCapture makes a great argument that a large number of the regulatory tools were captured and used by ne'er-do-wells who intentionally created false market signals for economic and political gain.

Unfortunately, as America is caught in a culture war with people clashing over the thesis/antithesis of regulation v. deregulation. We appear to have lost the ability to engage in the serious debate that would lead to a better mix of regulations.

Creating a better mix of tools is not simply the matter of adding a new layer of bureaucracy. Creating a good mix of tools requires the elimination of past regulations that proved problematic. Any new regulations should be carefully measured so as not to create adverse interaction with existing regulations.

Unfortunately, I fear our politically driven legislative process will do little more than to place political operatives in positions where they can, and will, do wrong in the future.

Militias and Tea Party

The Tea Party Movement and private militia movement of decades past share some of the same ideas. There is also share some crossover in the target audience; Therefore, the press (and ruling class) assume they are one and the same thing.

Community Organizers and street gangs share some of the same ideas, and there is often crossover between the target audiences of the two movements.

A conservative would be publicly flogged for pulling a Bill Clinton and trying to lump community organizers and street gangs in the same pile.

A Quick Recap of a Contemptuous Progressive Speech

Dingling dang dong.

Don't those right wingers know a thing about history?

The Boston Tea Party was about people upset with the national authority (England) usurping local powers.

The modern Tea Party Movement is about people upset with the national authority (Washington) usurping local powers.

Any Chomsky-loving professor in an ivory tower knows that these are two completely different things.

OO Tax Recap

To recap the Object Oriented Tax Post (OO Tax).

This system taxes an object that sits between income and consumption. It effectively combines the best parts of the income tax with a consumption tax.

Your income would go into a pre-tax account. You pay tax when you transfer money from the pre-tax account into a post tax account for spending. Deductible expesnse would not trigger the tax object.

The tax rate could be progressive. The progressive rate could be based on trailing income, calculated net worth, or a combination of the two.

This struture solves the problem of capital gains. An investor could make all of their trades on the pre-tax side of fence; so as not to distort investment decisions with tax consequences. Investors would get the full force of a progressive tax when they go to withdraw money for personal spending.

This means Warren Buffet will pay a higher tax rate than his secretary.

The tax is account based. The taxes would most likely be collected by the bank. This would shift a massive regulatory burden from America's businesses and help them compete.

The tax would actually be easier to administer than the flat tax.

The difficulty with taxes is that people have to touch each expense multiple times. Businesses have to withhold taxes, individuals have to pay estimated taxes. On tax day, we have to undergo the unpleasant activity of summing up all income and expenses for the year and paying the tax.

The OO Tax gets charged when people move money between accounts in preparation for spending. The system has people paying their taxes during a financial planning step. This will help Americans make better budgeting decisions.

As the name implies, the Object Oriented Tax was designed with object design principles in mind. It would be possible to design the tax so that it encapsulates and extends the current tax structure. As such it would be relatively easy to implement a design where the legacy tax structure runs alongside early adopters of the OO Tax design.

I like the idea because it would save me the day I spend compiling all of my tax records and filing taxes.

The Object Oriented Tax

In the early days of the object oriented design revolution, I engaged in a thought experiment in which I applied basic object oriented design principles to the problem of taxation. I developed a clever little reform that I like to call the Object Oriented Tax. One can abbreviate this as the OO Tax.

Our current tax system is form based. People accumulate all of their receipts for the year. On tax day, they sum up their income and tax deductible expenses. They then pay taxes on the differences between the two.

The difficulty of taxes lies in this act of keeping the receipts and summing things up.

The complexity of this system is not simply the simply the 1040 form. The system depends on a very complex reporting system that includes payroll withholding, estimated tax payments and W9 forms.

The object oriented tax takes a completely different approach to collecting and filing taxes.

The Object Oriented tax is account based. The system assigns a tax status attribute to financial accounts. An account is either pre-tax or post-tax. All income goes into pre-tax accounts. One pays taxes when transferring money from the pre-tax to the post-tax account.

Let's say you had $1000 in your pre-tax account and your tax rate was 25%. You would pay $250 in taxes during the transfer and end up with $750 for spending.

The tax rate in an object oriented structure can be progressive. The government could assign different tax rates based on past income or estimated net wealth. With a progressive tax rate, Warren Buffet might have a 50% tax rate. His secretary might have a 25% tax rate. Warren Buffet would have to take $1500 from a pre-tax account to get $750 spending cash, while his secretary would have to withdraw only $1000.

BTW, isn't the math interesting? Doubling the tax rate actually triples the taxes Buffet must pay to get $750 spending cash.

Of course, people are apt to have more than two accounts. This is where the object-oriented design comes in. The system simply assigns a tax status attribute to accounts. Transferring money from a pre-tax to a post-tax account charges a tax. People could have a variety of pre-tax investment accounts and a variety of post-tax spending accounts.

For example, a person might have pre-tax savings account, an IRA or a Medical Savings Account. On the post tax side of things, a person would have credit cards, checking accounts and cash.

A person would pay taxes when transferring money from the pre-tax savings account to the post-tax checking account. They would not have to pay taxes on transfers from the post-tax checking account to he post-tax credit card account.

Deductible Expenses

The system could allow currently deductible expenses to take place from pre-tax account. Charitable deductions, business expenses, medical expenses and other deductible expenditures could take place directly from pre-tax accounts.

The OO Tax and Budgeting

The great advantage of the OO Tax is that it has people paying their taxes during the budgeting process.

Having people pay taxes in the budgeting process makes them more aware of the affects of taxes on their spending.

By taxing an abstract object between income and expenses, the OO Tax effectively transitions the income tax into a consumption tax.

OO on Capital Gains

The object oriented tax solves the conundrum of the capital gains. It is bad economic policy to tax capital gains as such taxes adversely affect investment decisions. The OO tax puts investments in a pre-tax status allowing people to adjust their investment portfolio without having to factor in the tax consequences.

Rich investors can be soaked when they go to spend their gains.

Please note, the progressive tax rate can take into account both a person's current income and net wealth. This allows progressives to hit investors with a really high tax rate even if they don't realize much income in a given year.

I think progressives would like the structure. We can have our peoples' struggle against the rich and economic growth too.

Inheriting OO

The OO Tax also solves the problem of inheritance taxes.

Inheritance tax is problematic. People tend to leave estates with a disarray of paid and unpaid taxes. Taxing inheritance results in some double taxation. Removing the death tax leaves large chunks of income and investments untaxed.

The OO Tax provides a mechanism from straightening out this problem. Post-taxed accounts and assets could be distributed to post-tax accounts. Pre-tax assets would be transferred to pre-tax accounts. In some cases, there is substantial capital gains on post-taxed assets. In those cases, one might place the capital gained on post tax income into a pre-tax account.

The family farm, which is held in a pre-tax account, could transfer to a pre-tax account of he children and stay in tact. It only gets slip up if the children sell the farm and must realize tax.

The tax rate on inheritance would be based on the inheritor's wealth. This means inheritance tax becomes progressive.

So, if I left $1000 in pre-tax accounts to Warren Buffet and $1000 to his secretary, Mr. Buffet would have to pay his high tax rate on the gains. His secretary would pay a lower tax.

Because I want to avoid paying taxes, I might decide just to cut Mr. Buffet out my will and give all of the inheritance to his poor, underpaid secretary.

Of course, the converse is true. Let's say a trust fund baby is working as a burger flipper. This person inherits a million dollars. That person will now be hit with the high tax rate the money gained from burger flipping.

Conclusion

Taxing an abstract object between income and expenses allows us to create a hybrid tax with the best features of an income tax and consumption tax.

As tax payments happen in real time during account transfers, the tax is easier to implement than the flat tax, which still requires complex withholding and reporting efforts. One only has to touch each transaction once.

The tax transfers compliance from employers to banks, which reduces burdens on the employer, making America's businesses more competitive.

The tax is conservative in that it essentially treats everyone like a business and allows people to make investment decisions without having to pay a capital gains tax. The tax is progressive in that it allows tax rates based upon one's wealth and assures that the wealthy pay an onerous tax on any money they spend on themselves.

If the object oriented tax were in place, I would already be done with this horrid tax filing process, and could spend tax day with the patriots protesting on the Capitol Steps. Here's my photos from last year's tax day protests.

Death by Taxes © Sara Robinson

Renting the Phone

For decades, the telephone company would not let people own phones. The idea was that the phone was part of the network and you couldn't risk having iffy third party equipment attached to the network.

Each month, you would get a phone rental fee in the bill. At the time, I thought that renting phones was wonderful because we all shared in the cost of providing phones. It turns out that consumers paid many multiples of the cost of the phone.

The small decision of allowing people to own a phone transferred a sizeable chunk of wealth from the telephone company back to the people. Not only that, the change in law led to immediate advances in answering machines, fax machines, modems and wireless phones.

I've come to believe that increasing private ownership is a good thing.

Our current broadband debate is which group should own the last mile. Whoeever owns the last mile gets to dominate local media. Should it be an evil company like Comcast or the political drones in the municipality. The municipal ownership sounds intriguing until one realizes that it brings pretty much all local media under direct control of local political leaders.

The politicians arguing for broadband regulation are very much aware of the consolidation of political power that comes with the political regulation of broadband and municipal ownership of the last mile.

Yes, there are some big corporations (like Google...currently valued at $181 billion dollars) who will get even bigger with government ownership of the Internet. But the fact that politically connected companies get bigger as government gets bigger does not mean the system is market oriented.

As I look at the bad choice of domination by big government or big business, I can't help but think that if individuals owned the last mile and had direct property rights to the wire leading to a switch, then it would be possible to have our broadband and freedom too.

Of course, it is nice to have multiple houses on a single communication wire. It would be possible to do this bundling through a system of buyer's co-ops. With a buyer's co-op, each home in the branch would own a share of the wire. The co-op would pay costs as they occur. A very simple accounting system could handle the finances.

An industry of small private contracters would emerge to service the lines.

Just as letting people own their phone saved consumers millions, a system of direct ownership of the last mile would cost less, and increase the equity of homeowners.

NOTE: A system of co-ops saves money in two ways: It saves the overhead of the municipality or private business. Since small co-ops assume the cost of each of the lines, it reduces the costs associated with risk management.

The public debate about who should own the last mile (and consequently, who should dominate local media) gives us the choice of big government (the municipality) or big business (the cable company).

I believe that we could solve the cunundrum by finding a way in which the end users directly owned the portion of the last mile that they use. Either through direct lines to a telephone box, or by having the branch line owned by a co-operative structure.

Sean Hannity is Wrong on National Defense

Sean Hannity is wrong in his assertions that the Republican Party needs to be the party of strong national defense. His naïve assertion on this matter is both harmful to the Republican Party and harmful to our nation at large.

What American needs is a new generation of political leaders dedicated to preserving freedom and restoring Constitutional balances.

I think it more likely that such leaders will emerge in the Republican Party than Democratic Party.

The Democratic Party works by taking whatever issue polls well then making this issue appear foundational to the nation giving little thought about how the issue fits in with the system at large. Notice how a Democratic controlled Controlled Congress just past a massive health care bill with little thought given to the fact that states currently regulate health care.

Our founders disliked the system where all power was held by a monarchy. So they created a Constitution that assigned different tasks to different groups in a multidimensional structure.

The hope of the founders was that authority on decisions that affect every day life (like health care) would lie with the states, local government, private business or the people.

To preserve this system of distributed power, we need people at all levels of government dedicated to preserving this balanced framework.

The Federal Government was intended to handle an enumerated set of duties that required national unity. These duties included the ability to negotiate treatise and fight wars.

As you see, our Constitutional structure has the vast majority of people focused on the important job of living life. Only a few statesmen would be involved in making decisions about national defense.

Sean Hannity's notion that strong national defense should be the driving platform of the Republican Party is wrong in three way: The first is that the vast majority of political seats in this country have absolutely nothing to do with national defense. For example, since a governmor can't negotiate international treatise or start wars, it is absurd for a candidate to run on a platform of national defense. The governor should run on the governor's job. The national defense platform detracts from these roles.

Secondly, Hannity's open effort to drive doves from Republican ranks weakens the intelleuctual make up of the Republican Party. Hannity's concerted effort to drive doves from Republican rank not only strengthens the opposition, it has the terrible effect of polarizing the nation on the topic of national defense.

Finally one must consider that the need for national security ebbs and flows with changes in international conditions. Hannity's naïve stab at making strong national defense a platform position of the Republican Party puts the party and the country out of sync with the rest of the world.

This dysfunctional system has our nation responding to international threats based on who is in power and not on the nature of the threats themselves. More Iraqis died when Clinton turned his back on the brutal oppression of Saddam Hussein, than during Bush's war.

Our leaders in Congress need to have a robust decision making process that allows them to match our national defense effort to security threats and not domestic politics.

Having a large political party with the platform of strong national security creates a systemic imbalance. We end up with a dysfunctional national defense effort that fluctuates between excessive and insufficient attentional to international threats.

A healthy Republican Party would be dedicated to the Constitutional order. This Constitutional order demands well balanced statesmen to negotiate treatise and provide for national defense. A balanced statesman understands both the hawk and dove positions.

It appears that this Sean Hannity character on Fox News has never learned the difference between a Republic and Democracy. A Democracy would have us go to war based on a direct vote of the people (influenced by partisan rabble rousers).

What is killing this nation is that people like Sean Hannity will take their pet issues and try to make the pet issue a platform of a partisan group.

While this type of politics is okay on domestic issues, on the international front it creates a dynamic where we will be divided and conquered.

Our nation is greatly harmed by Sean Hannity and the Code Pink types who aim to make national defense a deeply divisive partisan issue.

The Republican Party would be wise to rebuke Hannity and to welcome both doves and hawks with the real focus on cultivating statesmanship and restoring Constitutional order.

Phone Neutrality

For decades, the AT&T monopoly was regulated with an ideal that could aptly be described as "phone neutrality." In the name of social justice, phone service was ruled with the notion that everyone must have the same service at roughly the same price.

ehe system placed heavy taxes on urban areas to pull wires to rural areas.

The great beneficiary of phone neutrality was the monopoly which used the ideal to cap demands for better services, and provided a mechanism to keep long distance prices high.

In hindsight, we see the era of phone neutrality led to technological stagnation.

Notably, farms and rural communities would have been better served by development of wireless technology. Unlike urban areas, rural areas have ample bandwidth for the community's communication needs.

The cost of phone neutrality wasn't just stagnate service. The ideal led to unnecessary environmental damage. The phone company disrupted ecosystems to string wires. They cut down numerous trees and did damage mining copper for the wires, and released chemicals into the environment to encase the wires in plastic.

For that matter, if we had a free market, we would have seen the emergence of cellular phones and complex networks sooner than we did in a regulatory climate ruled by the dictates of phone neutrality.

Quite frankly, the mass media internet would not have existed if not for the breaking up of AT&T and elimination of the ideal of phone neutrality.

From a historical perspective it is odd that Congress is even considering shoving a new ideal of internet neutrality down our collective gullets. The only need that the power grab seems to be fulfilling is never-ending need of the political elite for more power.

Just as phone neutrality was a bad idea that created artificially high prices and stagnated development, net neutrality is likely to set the internet in a negative direction.

On Change and Government

The free market is in a state of constant flux. Bureaucracies are comparatively static. So, why do we associate "change" with the growth of government?

The psychology of the association is simple to explain. We tend to give words and notice to those things that deviate from the norm. If you were trapped in a dank hole, a pin prick of light from the sun would be seen as a brilliant light. Meanwhile the inadequate shade of a saguaro is glorious shade in the mid summer Arizona sun.

There is a tendency to notice the deviation from the norm. A poet will write about the brilliant lights in a place that is comparatively dark and the shade in areas of excessive sun.

Back to the question of government and change: Change is the norm in the free market. Businesses seeking stability are apt to solicit government favor to shield their business from change. The public discourse is dominated by businesses seeking stability.

Bureaucracies are comparatively stagnate. Inducing change in a government agency requires public discourse about change to induce action.

If one takes public discourse into isolation, as is done in the academic world, one might end up associating businesses and the free market with stagnation and government bureaucracies with change.

History seems to show that free market reforms tend to lead to greater change (and, dare I say, social justice) than increased bureaucracy. The norm has a greater impact than the deviation from the norm.

Of course, "Change®" is often used as a slogan or brand in political discourse. It is a mistake to read anything into the name beyond the brand.

Politically Correct Gutter Mouth

Political correctness is a game where every word is measured for political effect, as opposed to words spoken in an authentic pursuit of truth.

As such, it is just as likely that a gutter mouth is engage politically correctness as it is for the light-tongued busybody.

I think it was a mistake for Conservatives to allow the term "politically correct" to be taken as a synonym for politeness. The real question is if people are using language to develop and convey ideas as opposed to simple political posturing.

Unfortunately, this association of "politically correctness" and "politeness" gives permission for the rogues of the world to lower the quality of discourse. It has become common for political leaders to drop the F-bomb, or n-word in blatant efforts to stop discourse.

People speaking in explicative are not necessary more engaged in the pursuit of truth than those that tiptoe around words with oppressive speach codes.

The term political correctness should apply to both excessive profanities and whitewashed language.

What matters is the commitment to truth and understanding.

I believe the quality discourse is civil. For the most part, politeness enhances discourse as it allows many different voices and perspectives in the discourse.

Anarcho Regulation

DeepCapture introduced a wonderful term "Anarcho-Regulation" to describe the current state of securities regulation.

I like this term much better term than "deregulation."

During the market crash of 2008, the world learned of an absolutely insane mix of derivatives and re-insurance that created a systemic fault in the economy.

I dislike using the term "deregulation" as most of these derivatives and financial instruments were designed to regulate the economy. For example, the credit default swaps that blew up were created by the massive Security Modernization Act of 2000 ... a regulation. Government backed re-insurance came from New Deal Legislation in the form of Fannie Mae and Freddie Mac. The Community Re-investment Act showed that Congress was pro-actively trying to tip the market toward social goals ... social engineering.

Most of the derivatives on the market today exist for the express purpose of regulating the economy. "Hedge Funds," as the name implies, weren't designed primarily as investment tools, but as tools to hedge investments. Short selling is justified with the claim that it enhances liquidity. Above all, insurance exists as a means of regulating risk.

Modern financial thinking has been dominated by a desire to regulate the market. What happened in the Clinton/Bush years is that the government realized that it was ill equipped to monitor the bizarre mix of derivatives that was being used in the financial industry. So, the Feds simply took their hand off the tiller with the hope that the market would magically reach a stable equilibrium.

I believe one should use the term "deregulation" to describe the removal of a regulatory machinery. What our leaders did in the Clinton/Bush years was to leave all off machinery designed to regulate the economy running at full bore ... but with no supervision.

The term "anarcho regulation" aptly describes a system where one leaves the regulatory machinery in place, but removes the supervision.

I applaud Deep Capture in their effort to reduce the abuses of naked short selling and FTDs.

The drum i wish to pound is one that reminds the world that short selling is a tool designed to regulate a stock. Unfettered naked short selling is best described anarcho-regulation. The deregulation would involve the actual removal of the regulatory machinery. Since naked short selling exists to regulate stocks, deregulation would eliminate the regulation that make naked short selling possible.