Using Technology to Deepen Democracy, Using Democracy to Ensure Technology Benefits Us All

Friday, June 15, 2012

At the Heart of the "Financial Singularity" There Is Not Mystery But Fraud

[It s]ounds a bit like a science fiction novel; are the financial algorithms, models and computers taking over from their human creators? Have we reached a financial singularity? Is this what a world created by the demonic love child of Gordon Gekko and Bill Gates would look like? This would be an amusing thought if it had not leapt from our collective Kindle screens and into our real world economy. But as Eric B. and Rakim might say, this ain’t no joke. Have we reached the point where our financial markets are so complex that we no longer understand how they really work? And if so, how can we manage what we don’t understand?
It is true that many did not understand what was going on when the digitization of planetary monetary transfer enabled a handful of predatory con-artists to engage in incomparably vast-scaled rapid-paced looting and fraud via financial algorithms and financial instruments like the bundling of subprime mortgages into phony prime assets. But, then, it is always true that the marks don't understand what is going on when a scam is underway.

What it is crucial to emphasize about this provocative little science-fictionalized ditty about a "financial singularity" is that -- even if it is coming from a place a disgust and despair about our unprecedented economic distress and about the suffering and injustice it has brought about -- this way of framing the crisis functionally abets the scam it decries.

It is not computers and programs and autonomous techno-agents who are the protagonists of the still unfolding crime of predatory plutocratic wealth-concentration and anti-democratizing austerity. The villains of this bloodsoaked epic are the bankers and auditors and captured-regulators and neoliberal ministers who employed these programs and instruments for parochial gain and who then exonerated and rationalized and still enable their crimes.

Our financial markets are not so complex we no longer understand them. In fact everybody knows exactly what is going on. Everybody understands everything. Fraudsters engaged in very conventional, very recognizable, very straightforward but unprecedentedly massive acts of fraud and theft under the cover of lies, and have very nearly destroyed civilization in so doing. If our governing institutions cannot recover quickly enough to become capable of organizing an effective and equitable collective address of catastrophic anthropogenic climate change and resource descent then they will have succeeded in fact in destroying civilization.

The very experience of "accelerating change" that has preoccupied the discourse of the digital-utopians and futurologists throughout the post-Reagan neoliberal era has always, in my view, simply been the way increasing precarity for ever vaster portions of humanity and earthly life -- produced by outsourcing, crowdsourcing, externalizing, informalizing, union-busting, welfare-looting, deregulatory, race-to-the-bottom globalization -- is experienced and described from the vantage of the privileged people who either benefit from this destabilization or who (rightly or wrongly) identify with the beneficiaries of that destabilization.

When it comes to the financial crisis, we are not living in a science fiction novel, we are living in a bleak naturalist novel.


Anonymous said...

As someone with quite a bit of experience in the field, I feel that you are wrong. We do not know whether competing HFT algorithms are going to result in unexpected feedback loops. After some bad experiences, most (as far as I know and hope) are now being built in with hair-triggers to alert human beings at first sign of trouble (as well as with certain firewalls where possible), but given their trade execution speeds (on the order of microseconds), millions can be (and periodically are) lost before a human can correct things. It's why we pay our quants so well – a mistake in algorithm design can cost firms lots of money. We also do not know what is the source and intent of much of the liquidity in dark capital pools. Indeed, they are designed this way – to allow firms to execute large trades without competing firms realizing what is going on and arbitraging away some of the gains. We can probe some of that liquidity by placing and quickly canceling orders, but then everyone knows that everyone else is doing the same thing, so the reliability of the insights we glean are suspect. Finally, we do not know how assets and risks are distributed across the shadow banking system. Even if we know our counterparties well, we do not know how well covered their positions are, or just how linked a particular transaction is to other positions in the market. Indeed, this is now a problem that has moved out of the SBS – no one wanted the Greek default to be officially classified as a default, for instance, because no one really had any idea who would be left holding the bag of CDS dogshit that was issued to insure Greek debt.

It's not fraud and theft, at least not in the legal sense of the words. The people in legal are just as smart as our quants. Everything is made sure to be above board. Unquestionably there are instances of malfeasance, insider trading, or whatever else, but these are not the bulk of the problem. There are also periodic but infrequent cases of knowingly screwing over your counterparties, but this is not the big problem either – acquire a bad reputation, and no one will trade with you.

The problem is scale, complexity, and leverage. The size of the SBS alone is ~$60 trillion and nominal value of derivatives contracts is probably around $500 trillion these days (which, in a world with a global GDP of ~$80 trillion is a bit ridiculous). A decent guess would have HFTs responsible for around 50% of all daily trading volume, and these are machines trading with machines using algorithms that even their creators do not have a holistic understanding of (parts of which depend on some rather academic assumptions holding true, in any case). And liquidity risk (i.e. you can pay everyone, just not at the same time) is always a much bigger threat than credit risk, which is why the US government's promise of $15 trillion in backstops prevented a much bigger meltdown in late 2008 than the one that occurred, with the government having to actually spend that money.

Working in finance today is staring every day into a Nietzschean abyss. Everything works while one can trust all other players to believe that everything works, and to behave as they should. But it's all balanced on a razor's edge. Push the wrong place at the wrong time and at least some players are likely to lose a lot of money, and it's impossible to tell who among us those will be. The non-financial economy is not a mark in a con, it's collateral damage in a system metastasized by an explosion in our mathematical modeling and IT capabilities.

Dale Carrico said...

As someone with quite a bit of experience in the field, I feel that you are wrong.

I don't doubt that is what you "feel" -- I daresay you wouldn't have survived long experience in the field without finding your way to feeling that way.

But I know you are wrong, a knowing based on an understanding of moral hazard and risk/ cost externalization and ibgybg and unaccountability and skewed incentives and on the serial failures in my lifetime that testify over and over and over again to the same sorts of people in the same sort of situations making a killing by telling lies (including lies to themselves) in ways that kill -- the S&Ls, metallgesellschaft, Enron, the financial crisis... I mean, you're talking suavely about risks when Dimon's testimony just HOURS ago, HOURS ago, was still equivocating on bets he pretends were risk-mitigating hedges. It's a con, and he knows it, and we know it, and he knows we know it, and you know it, too.

Working in finance today is staring every day into a Nietzschean abyss.

No, it's a pig staring into a trough. (rimshot)

Everything works while one can trust all other players to believe that everything works, and to behave as they should.

But what you are calling "everything working" IS what I am calling the theft and fraud.

Here is a bigger picture version: What if Wall Street was and is doing is NOT more productive than not, NOT more optimizing than not, NOT more meritocratic than not, NOT more socially good than not -- what if the "working" has always been a scam working for a few at the expense of almost everybody else? And of course, that's not even remotely far-fetched, it's not a "what if" -- we are living right now in the ruins of these obvious truths.

I think what you are forgetting or possibly even hiding from yourself with these naturalizing force metaphors of "metastasization" and "explosion" are the conscious agents who were and are deploying these instruments for parochial gains to the ruin of the world.

Of course, the issues of scale and complexity you are talking about are indispensable factors to telling the story of the particular scam presently in play -- but what matters more are the ways in which the usual cons are being facilitated through the opportunistic manipulation by the usual con artists of precisely these issues of scale and complexity, what matters are the ways in which very commonsense efforts to regulate malfeasance, to multiply monitors, to break up too big to fail, to introduce per-transaction fees to slow down these velocities, to build firewalls between gambling and investment, or to compress compensation disparity, and on and on and on are being actively resisted by the real people who know what they are doing and who know very well that they benefit from the factors you mention.

This is not about a great mystery, this is about mystifications, the smokescreen behind which a con is being perpetrated that is destroying the world before our eyes.

Summerspeaker said...

Great analysis here, Dale. I think the complexity perhaps matters a little more than you give it credit for, as the sheer scale of the technological and social networks involved facilitates mystification and elitism. You have various levels of fraud and theft, ranging from system as its supposed to function - to maintain the bourgeoisie on the backs of workers - to knowing con artists.

Dale Carrico said...

Thanks, Summer. Actually I don't mean to imply at all that the complexity doesn't matter, what "the complexity" is standing for here is the furniture and terrain on which the bad actors I'm trying to foreground are playing. Rather than deny this, I am trying to insist that we not think of this complexity as some independent variable when I think what matters more is that fraudsters recognized what could opportunistically made of this complexity, exacerbated it, and then resisted efforts to identify and mitigate it with oversight and regulation. You are also right that the fraud happens in different layers with some people engaging in socially injurious practices because they don't understand all the consequences of what they are doing and others because they are ideologically committed to not seeing this (or so blinded by parochial gains that they can't), whereas there are definitely people who knew they were doing false, destructive, and illegal things and didn't care as much as they cared for the money and power they were getting. There is no question that many people broke laws and committed fraud even by the strict letter of existing laws and the fact that nobody has gone to jail sets the scene for the inaction and ineffectuality playing out at the other layers you mention, the stuff that should happen at a structural level checking corruption and conflicts of interest rather than incentivizing these things as happens because profits are so high and regulatory capture so absolute that bad actors are fully insulated from the consequences of their terrible actions and so on.