Today was Hedge Fund Day: lots of testimony.
I was enjoying Professor Andrew Lo's (MIT Financial Engineering Laboratory Director) testimony. He drew the distinction between risk and systemic risk.
Risk is easily understandable; one invests, and one may, via capitalization, achieve positive returns or one may lose. Systemic risk is the sort of risk that is currently driving the government's reaction to this evolving economic situation. It is generally understood as risk that would create a collapse of the system. This is the basis of the "too big to fail" phenomenon, that is spurring gigantic bailouts of individual companies. Clearly this is a problem, because the scale of the risk, the inherent denominator of capitalistic investment, is now being plied to the strength of the system as a whole. In other words, if a capitalist entity fails, capitalism fails. Others would put this as, if a market entity becomes market, then if that entity fails the market goes with it. I would say they are the same thing (in this case, systems of debt/capital commodification).
Above are some network diagrams of the correlations among hedge fund indexes. Sweet, huh?Looking at things as a network is always a good schematic, in my opinion. Nothing is an island, and that certainly goes for financial systems. And, if we are discussing systemic risk, then certainly interconnections and correlations between risk is very important, as Professor Lo argues.
In fact, let's hear it from Professor Lo (from his written testimony before the committee):
"By looking at the financial system as a single portfolio, several useful measures of systemic risk can be derived by applying the standard tools of modern portfolio analysis."
WHAT??? verrrrrripppperrrrererrrrrrrrrrrrrrrrrr.... (the sound of the pdf being rewound)
"By looking at THE FINANCIAL SYSTEM AS A SINGLE PORTFOLIO, several useful... etc."
Now, let's cut to a single, modern portfolio, one doing very well right now.
The graph is shamelessly stolen from the excellent blog, Calculated Risk, which you should definitely read if you are interested in any of this sort of crap.The portfolio, as you see, is that of the Federal Reserve. The president of the Dallas Fed predicted it will go to $3 trillion in assets by the end of the year. That is 20% of the GDP.
Let's recap. Because of systemic risk, the Fed is buying assets and lending out money like never before. The best way to analyze risk in the current markets is to view the market as a single system. And now the Fed is quickly, at an incredible rate, becoming the lynch pin of that single system, both in terms of the networks of where the debt flows are coming from (they have gone from being the lender of last resort to the biggest and only lender).
Get it yet? To fix the problem of an incredibly complex and massive system of value, it is best solidified into one system, for the continued maintenance of that value.
NATIONAL - IZ - ATION
Now: this isn't nationalization in the models of nationalization as it has occurred elsewhere in history. We are on entirely new ground here. This means two things, as I currently see it.
One: we will not have the economy "seized". Instead, companies will continue to try and save what assets they have by running to the Fed's door to keep their companies from going under, until eventually, the Fed controls so much of the country's economy (i.e. not only will the government determine monetary policy, they will control debt policy) and we will see a reverse panic. Everyone will take their money to the bank to keep it safe and valuable. To keep businesses operating, the government will have to spend, and, eventually direct large parts of the economy and its markets via its "owned" companies to keep the country going. Regulation will morph into direction/ownership, not by authority, but by de facto conditions.
Two: because this is a unique situation, it will become a positive feedback loop. Companies will not see it coming until it is too late, and they will be forced to go to the Fed like everyone else. This is the nature of the panic. But it will also be make it an unplanned nationalization, because it will be rolling, and not planned from the beginning. This means that many things could go wrong.
The question that I'm thinking about in my head is, what would the country look like with a nationalized economy? It would not be "state-owned", that's for sure. Not in this country, go back to Cuba! But it would be drastically different. If one considers American capitalism before the great depression to the SEC and Fed controlled economy afterward, we see an incredible difference in the philosophy of the market. No doubt there will be a major shift after this "second great depression", and nationalization is what it may look like.
Clearly companies will not be dissolved into worker combines. However, I can see carefully calibrated "free markets" of related industries that work within current anti-trust laws in managed competitions like those for federal contracts. This could mean strange things for free trade; I think it might drastically reduce the number of companies in particular industries, however, unless the economy, at the same time as it unifies into a "single portfolio", is managed into zones of much smaller size that will reduce the size of corporations and their national influence. Anti-trust could be taken along regional boundaries.
Bureaucracy would increase, with all these regionalized regulatory zones and entities. I think that this regulation would be the link that would be the national arm of the economy, and also divide it into regions and industries. Call them market divisions, if you wish. Fed banks, in addition to maintaining the reserves of cash, would also maintain those of debt, selling regionalized treasuries and industry securities, the way that it does government securities now.
The biggest question is what would happen to the individual worker. I would hope that an increase of union influence, combined with a larger number of member workers and an overhaul of their bargaining power would allow the workers to enter these new market zones as equals in the productive relationship, but I have a feeling we will end up the forgotten partner, and the better functioning of the macroeconomy will encourage its controllers to take more surplus value from the workers on the micro level.
Now, I'm going wildly out on a limb here, talking about things of which I have only a limited, amateur understanding. But, there will clearly be more regulation by the time we're through, and if this regulation is clever, it will act with a better understanding of systemic risk, which, perhaps, is what the folks in the Fed think they are doing now by buying tons of pieces of businesses. There's no doubt that we are moving towards nationalization right now, more than ever before. The only question is how far it will go, and by the fact that it does not seem to be having much more effect in the economy other than acting as a giant asset magnet.
we will see...
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