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Economic Ecology Makes or Breaks Financial Systems

2010/12/14

For December, the Center for Adaptive Solutions will be offering several posts to explore alternatives to the “business as usual” economy.  My post today grows from two comments made here and here on December 7, 2010 to the New York Times Room for Debate regarding the size and regulation of mega-banks.  It also builds on a comment made here on November 5, 2010 to Juliet Schor’s Plenitude Blog post of September 29, 2010 on financial reform, and on a comment made here on December 10, 2010 in response to a note stemming from the comment on the Plenitude Blog.

Today I’m discussing fresh perspectives on the systemic context or ecology in which economies operate.  Seeing the economic ecology offers value by noting and assessing unexpected strategic warnings and opportunities.  As input to the process, whether by intention or simply by living in the world, we all have some perspectives on living in a world economy – in effect, how things fit together and affect us.

Sorting out the good stuff

The challenge to converting perspective into value lies in assessing the points on the spectrum of systemic perspectives.  We need a way to sift out the good stuff.

Some perspectives may appear more different than they become when examined.  For example, we may decide to focus on personal efficacy, responsibility, and capability.  Or we may expand the personal focus to consider interactions between and among people and institutions, including private and public entities.  An expanded focus captures a continuing diffusion and concentration of layered cause and effect that is more useful to address than to ignore.  But the personal focus clearly offers real value in an expanded frame.  Therefore, it’s not an either-or scenario between personal and expanded focus.

Interestingly, an expanded focus does not result in any necessarily permanent agreement across time and events on how to deal with layered cause and effect in specific cases.  Expanded focus merely acknowledges the reality of complexity, and the necessity of informed and considered choice, to achieve ongoing shared adaptability and resilience while maintaining personal integrity and community value.

In addition, being systemic does not ensure success, or even have much to do with positive benefits.  Failed systems differ from successful systems because successful systems include positive feedback loops.  Failed systems do not adapt to secondary effects, which eventually undercut the viability of the overall structure that enables the ultimately failed process to operate until it fails.  In contrast, successful systems can continue as long as they don’t encounter more internally coherent systems that in addition also have more resources in the same operating space.  Absent some form of superior mass or resource, whether physical or social, simply being coherent is insufficient to ensure success, or, importantly, even to offer positive value.

Phase shifts

This discussion has been running for some 7,000 to 10,000 years of living in ever-larger groups.  Of course, sometimes we live in smaller groups when things get out of hand.  When things do fall apart, we get pushed into retrenchment mode in one part or another of the planet for four or five hundred years at a crack as a corrective phase shift phenomenon.

Phase shifts are important events worth paying attention to.  Phase shifts include personal action as well as group action because we live as individuals, and we also interact both as individuals and as members of groups.

It would be useful if we can learn how to influence economic and social complexity to shift the corrective phase shift phenomenon from bloody awful to something less destructive while growing something more constructive.  In particular, it would be valuable to enable ongoing phase shifting (bottom up personal energy and efficacy) without breaking all the crockery in rigid structures that shatter rather than adapt.

The personal impulse to act as responsible individuals is a critical and necessary condition in the phase shift phenomenon.  It seems equally clear that part of personal responsibility is to be alert to the impacts and benefits of acting jointly as well as severally in a society that has a very large number of moving parts, where positive results need room to grow, and where negative side effects need to be addressed by each of us and also by all of us.

Scale matters greatly in phase shifts, both individually and institutionally, because the world includes a very large number of actors and aspects.  It’s necessarily an ongoing discussion because it’s a moving target as major and minor factors emerge, interact, modify, merge, split, disappear, or reappear.  This is getting at something useful. The value in examining the ecology within which economies operate is the value in assessing the ongoing churn in factors that represent the economy itself.

Negative externalities and multi-participant issues

For a moment, let’s look at how economic ecology can work.  Economic ecology differs from standard commercial activity analysis.  Economic ecology assesses uncaptured negative externalities.  Negative externalities look like positive economic activity when one-sided economic accounting and modeling account for the direct work to undo any part of the undesired effects without capturing the full negative impacts of the undesired effects themselves.  Therefore, economic ecology offers patterns of value by assessing unexpected warning flags and opportunities stemming from changes and challenges that emerge from the surrounding context within which firms operate.  It’s a useful conversation about keeping your strategic head up and alert.

The systemic value in keeping your strategic head makes it valuable to take on the multi-participant issues that engulf regions and populations.  Multiple participants are a key ecological problem feature, and make ecological problem ownership a challenge.  The challenge exists whether the ecology is the physical environment from physical activity, or the economic environment from financial activity.  There’s often no one best way forward in multiple-participant problems.  When a large problem has no real owner, it’s important for social resources to intervene to work toward reducing negative results and expanding sustainable, resilient positive results.

Mega-bank Behavior – Roots

An active case in point for living in a society that has a very large number of moving parts, where positive results need room to grow, and where negative side effects need to be addressed by each of us and also by all of us, is the matter of mega-bank behavior.

Mega-banks may look like an odd object to pull from the bucket of issues, but maybe it’s not so odd after all.  Specifically, even as tribes in the woods we traded items of value for the use and beauty they offered.  That took some medium of exchange, whether direct goods initially, or later the use of abstract units of agreed and storable value called money.

And with the idea of money came the business of managing money like any other valued commodity.  So now we have banks as a core tool enabling goods, services, and promises of future work to be shared across time and distance.  Given the usefulness of a banking system, there’s value in looking at mega-bank behavior to make sure it works in ways that both sustain some form of banks as entities, while ensuring the primary transaction tool and resource mobilizing benefit of a banking and financial system for all of us.

Mega-bank Behavior – Bingo Jackpots and Leveraged Bets

In looking at the systemic stability issue posed by mega-bank behavior, we need to look at the results stemming from the mega-bank community as it seeks to maximize returns from the leverage it exercises from its position of overwhelming market power across financial and other sectors.  The market power manifests as the sheer ability to engage in work that highly aggressively cross-connects asset classes and funds flow streams to garner private transaction benefits that far exceed the economic value of managing transaction risk and mobilizing financial resources.  The incentive to sustain jackpot-seeking behavior resides in the huge private rewards that occur when pervasive high-risk leverage is socially indulged.  Although not sustainable (see 1929 and 2008), bingo jackpot behavior itself is systemically enabled when publicly funded but non-ecological cash keeps jackpot incentives in play despite their systemic pratfalls.

The results stemming from jackpot-seeking behavior are systemically destabilizing and persistent because mega-banks are sufficiently large to influence the five big issues within which the US economy now operates –

  • The income inequality issue,
  • The financial re-regulation issue,
  • The globalization issue,
  • The structural health issue, and
  • The carbon-tax issue.

The five issues are connected through the jackpot-focused financial sector because financial jackpot behavior drives dysfunctional system-leveraged bets on all the other economic sectors, which depend on access to financial sector capital for their projects.  Employees across the sectors of the US economy also are connected to the five issues by the fact that all employees are also producers, consumers, borrowers, patients, have dependents, and live in the common public space in community after community across the country.

The Larger Ecology of Leveraged Bets

The bank hunger for cash to fund leveraged bank bets forces non-financial firms to compete for bank funds by hyping current profits to bid for operational and project funding from banks.  Firms hype their profits by moving jobs overseas to low-wage areas, by not sharing labor productivity gains with workers, by ignoring negative externalities where possible, and by not risking major investments on new long-term, transformational energy and transportation technologies and US-based manufacturing.

Vanished jobs and flat pay flatline broad-based consumer incomes and hike consumer demand for unsustainably low prices for food and manufactured goods.  The demand from jackpot financial pressure for high profits and quick returns in the face of low prices can only be met by corporate agriculture subsidies and commodity farm operations, and by outsourcing manufacturing to low-wage countries.  The process becomes circular and self-reinforcing as each firm and its individual employees struggle to keep up with the financial sector drumbeat.

Note that outsourcing jobs overseas to reduce price pressures for consumers, which hurts US jobs and consumer income, is a classic positive secondary effect with negative side impacts.  In this instance, the secondary effect reinforces the primary profit narrative to boost the ability of firms to bid for funding by mega-banks, which otherwise will put cash into their own leveraged financial bets.  But workers with no jobs or lower-level jobs or stuck pay levels cannot buy goods and services without unemployment income and borrowing.

The point about outsourcing jobs as a secondary effect is worth emphasizing for its impact on the stability of an economic ecology.  Even with low prices, the flat consumer incomes drive demand for consumer debt – offered at high rates by the financial sector.  Debt-based consumers set the stage to add to long-lasting job collapse cycles when the jackpot-focused financial leverage bets go bad as the house of cards collapses.

The big-bank scenario of jackpot financial leverage behavior is not an issue of evil people.  However, the jackpot financial behavior calls for countervailing coherent action across the five issues cited above.  The economic ecology requires action to displace the putsch that the financial sector engineered since the late 1970s.

Systemic Response to a Leveraged-bet Ecology

To address the financial sector’s environmental structure and resulting incentive-based appetite for unsustainable leverage, and to increase the economy’s resilience in a fast-moving world, fiscal and regulatory policies need to work together in a more operationally sustainable economic ecology.

1. Fiscal Policy

On the fiscal policy side, the key initial step is to spend money on direct projects, state budgets, and immediate and long-term unemployment benefits.  This action will boost job growth and a more resilient financial environment by driving stronger income-based consumer demand and more viable families and communities.  As a long-term action, it’s necessary to fund US debt, US budget sustainability, and productivity-enabling US workforce health, by making personal income taxes as progressive as the reality of US household incomes.  Fiscal budget sustainability also includes aligning social security taxes with all income, and aligning progressive income taxes with earned and unearned income over $250,000 – especially for the top 1%.

Some information… The top 1% garners over 20% of all US household adjusted gross income, and the top 2% (i.e., those at $250,000 and up) earn over 24% of all income.  Economist Robert Reich noted that such severe income distortion makes the US less stable as a living national community.

Addressing systemic income disparity does two things.  We can acknowledge we’re all in this together to create the economic framework and living communities which enable all incomes including high incomes.  And we can acknowledge that high incomes also include high and real personal accountabilities to support the human framework in which we all live and work.

2. Regulatory Policy

On the financial regulatory side, reduce incentives for over-leveraged bingo jackpot behavior by releasing jackpot-induced financial sector profitability into the producing economy, and by reducing the instability from over-connectedness across asset classes and funds flows.  The game-changing signal is to separate commercial and investment banking.  The primary goal is to blunt the incentive for combined commercial-investment mega-banks to use deposit-based funds flow to engage in the systemically dangerous financial mechanics of bingo-based short-term leverage strategies across asset classes and funding sources.  The benefit to the economic ecology is to transfer bank attention away from bets on mega jackpots, toward bread-and-butter funding for more externality-aware business investment in long-term plant, equipment, and innovation.  For more information on key financial sector policy actions, see financial safety and resilience and public policy re-set.

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3 Comments leave one →
  1. 2011/01/02 3:31 am

    For an interesting interpretation of a financial ecology’s systemic framework, see the post by Tom Bigda-Peyton at http://www.aneconomyofmeaning.wordpress.com/2010/12/30/financial-services-and-the-crash-of-2008-signs-of-a-failing-system/.

  2. 2011/01/03 2:32 am

    After this post went up, James Surowiecki wrote in The New Yorker’s January 3, 2011 issue that today’s unemployment is significantly driven by insufficient demand from consumers and business investment due to the current severe business cycle. He asserts current low employment is not due to a structural change in the nature of the economy. His point about insufficient demand resulting in a reduced need for workers is consistent with this post’s observation that a major driver behind the insufficient demand in the economy stems from the financial ecology now operating in the economy. See Surowiecki’s perspective at http://www.newyorker.com/talk/financial/2011/01/03/110103ta_talk_surowiecki.

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