Sunday, August 7, 2011

S&P and the tale of $2 trillion (or $4.2 trillion)


In Alfred North Whitehead’s 1933 Adventures of Ideas, he joins other mathematician physicist philosophers from the period who admirably sought to reconcile societal dissonance evidenced in monetary policy, war, and the transforming gestalt of the role of Christian morality in a globalizing world. Whitehead is well known for his critically acclaimed principle of the “fallacy of misplaced concreteness” in which he shows the consequence of the failure to apprehend the nature of the essence of things and the conventional understandings of the same. He explores the social derivatives of this fallacy in which people separate, enter conflict (including going to war), and engage in destructive acts over ‘truth’ that is neither ‘true’ nor ‘reality’ – simply an unconsidered consensus.

The events of Friday of this week – the capping of a contentious and fallacious closely averted disaster around the U.S. government’s inability to find a path to accountability which, like the gusher in the Gulf, will emit even more toxic sludge when it fails in a few short months – provide a wonderful opportunity to consider Whitehead’s long forgotten wisdom.

Written in 1933…

Ironic, isn’t it, that the “remote chemical discovery” (don’t you love his resistance to using the term ‘alchemy’?) that would render gold of little value was anticipated to be more readily replaced by paper currency whose “number can increase…at their arbitrary will.” Who would have thought that a mathematician philosopher in 1933 could have seen into the mind of Ben Bernanke?

This week, the markets and politicians provided a plethora of fodder for InvertedAlchemy. However, what struck me most was the concrete fallacy that emerged around the controversy triggered by S&P’s decision to downgrade U.S. debt. Let’s be clear, S&P and the rest of the government-protected monopolist rating agencies (NRSROs), are incapable of rendering meaningful risk assessments due to the fundamental detachment they all share from assessing future productivity. Sell-side rating agencies, given the fact that they must serve as the concubines for two equally maniacal lovers – the debt sellers who buy favorable treatment and statutory buyers (like pension funds, banks, insurance companies and others) who are required to hold ‘investment-grade’ investments – couldn’t be objective if they tried. In their deal with the devil, they get monopoly protection through legislation in exchange for always saying nice things about those who protect their monopoly. If this sounds corrupt, it does because it is.

So, imagine the ‘gotcha’ thrill that happened when someone at the Treasury (represented by John Bellows, Acting Assistant Secretary for Economic Policy) found S&P’s much ballyhooed $2 trillion mistake. Clearly, the argument went, if you subtracted the $2.1 trillion estimated cost savings from the CBO analysis rather than adding it (which by the way, folks at the Treasury, makes this a $4.2 trillion mistake), the economy would look much better – so much so that a down-grading wouldn’t be justified. Tragically, by focusing the public attention on the gnat (o.k., rather large pterodactyl, but who’s measuring these days) of the error, the public fell for the S&P bashing without looking at the real numbers. So, to be clear, rather than being over $90 trillion in the hole – based on the error – we’ll only be something over $82 trillion in the hole. Don’t you feel better? Moody’s and Fitch should feel great that our nation is falling faster into unsustainable growth of debt and entitlements at a pace that would require us to more than quadruple our GDP growth and, because of their august wisdom and impeccable insight, they still see ‘investment grade’ when they’re looking at the U.S. debt.

The Chinese are right. We must get our financial house in some semblance of order. Note that I wish we would actually begin telling ourselves something that more closely approximated the truth but I’m not sanguine that that’s likely anytime soon. But between now and then, we need to revisit Whitehead’s axiom. Ratings are not truth. Ratings are not derived from independent, forward-looking assessments of productivity. Ratings are illusions created to fulfill a demand for a specific type of investment instrument whose production is required by statute. If we want transparency, we’ll have to tackle it through banking, insurance, pension, ERISA, and securities reform and that’s unlikely given the House divided. S&P is neither the cause nor the effect that people have made them out to be. They were complicit in the failure of financial products in 2007 and 2008 and, with their co-monopolists at Moody’s and Fitch, they will contribute to more market carnage in the future. But, let’s be clear, it’s all of our reliance on a fallacy of misplaced concreteness that precludes We the People from raising our voices to advocate for greater risk assessment and future productivity insight. And that’s something we can all change today.

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Thank you for your comment. I look forward to considering this in the expanding dialogue. Dave