January 2nd, 2012 / 2:40 pm
Power Quote & Random

God is a collective action problem

I read maybe a weird amount about finance and economics. I’m not entirely sure why: it’s not as if I have the means, educational or otherwise, to evaluate the truth of what I’m reading. Felix Salmon is one of my favorite writers in this area. He and others have been talking up this post by Steve Waldman as uniquely informative and thought-provoking. I read it and I felt that this was fair, and then I started thinking (as I will so-painfully-predictably do) about its applications to writing. You should read the whole thing, but I’ve put together a short version (with most of the assertions and very little of the evidence-by-example, the gold standard of persuasion!).

I’ll summarize in advance: finance in general, and banks in particular, are hopelessly complex and opaque, but this is basically a good thing. It allows us to trick ourselves into investing despite our naturally risk-averse nature by hiding the risk inherent to investment. Economic development requires us to solve a classic collective action problem: nobody wants to be the first to invest, but we need broad investment and many failed enterprises in order to generate returns–and benefits in terms of human welfare. Banks help us to move past this problem by lying to us (though they themselves believe the fiction). They can’t eliminate risk, but they can and do hide it. This opacity allows them to commit fraud and other shady activities, but it’s probably necessary to develop something like modern civilization. My edited-down version of Waldman’s argument, and some attempts to link this to writing and reading, are after the fold:

Finance has always been complex. More precisely it has always been opaque, and complexity is a means of rationalizing opacity in societies that pretend to transparency. Opacity is absolutely essential to modern finance. It is a feature not a bug until we radically change the way we mobilize economic risk-bearing. The core purpose of status quo finance is to coax people into accepting risks that they would not, if fully informed, consent to bear.

Financial systems help us overcome a collective action problem. In a world of investment projects whose costs and risks are perfectly transparent, most individuals would be frightened. Real enterprise is very risky. . . . One purpose of a financial system is to ensure that we are, in general, in a high-investment dynamic rather than a low-investment stasis. In the context of an investment boom, individuals can be persuaded to take direct stakes in transparently risky projects. But absent such a boom, risk-averse individuals will rationally abstain. Each project in isolation will be deemed risky and unlikely to succeed. Savers will prefer low risk projects with modest but certain returns, like storing goods and commodities. . . . If only everyone would invest, there’s a pretty good chance that we’d all be better off, on average our investments would succeed. But if an individual invests while the rest of the world does not, the expected outcome is a loss. . . . If everyone is pessimistic, we can get stuck in the bad equilibrium. Animal spirits are game theory.

This is a core problem that finance in general and banks in particular have evolved to solve. A banking system is a superposition of fraud and genius that interposes itself between investors and entrepreneurs. It offers an alternative to risky direct investment and low return hoarding. Banks guarantee all investors a return better than hoarding, and they offer this return unconditionally, with certainty, without regard to whether other investors buy in or not. Basically, the bankers promise everyone a return of 2 if they invest, so everyone invests in the banks. Since everyone has invested, the bankers can invest in real projects at sufficient scale to generate the good expected payoff of 3. The bankers keep 1 for themselves, pay their investors the promised 2, and everyone is made better off than if the bad equilibrium had obtained. Bankers make the world a more prosperous place precisely by making promises they may be unable to keep. . . .

Like so many good con-men, bankers make themselves believed by persuading each and every investor individually that, although someone might lose if stuff happens, it will be someone else. You’re in on the con. If something goes wrong, each and every investor is assured, there will be a bagholder, but it won’t be you. . . . If the trail of tears were truly clear, if it were as obvious as it is in textbooks who takes what losses, banking systems would simply fail in their core task of attracting risk-averse investment to deploy in risky projects. . . . This is the business of banking. Opacity is not something that can be reformed away, because it is essential to banks’ economic function of mobilizing the risk-bearing capacity of people who, if fully informed, wouldn’t bear the risk. Societies that lack opaque, faintly fraudulent, financial systems fail to develop and prosper. Insufficient economic risks are taken to sustain growth and development. You can have opacity and an industrial economy, or you can have transparency and herd goats.

A lamentable side effect of opacity, of course, is that it enables a great deal of theft by those placed at the center of the shell game. But surely that is a small price to pay for civilization itself. No?

In a postscript, Waldman says that “there are alternatives to goat-herding and kleptocratically opaque semi-fraudulent banking. But adopting those would require not ‘reform’ but a wholesale reimagining of status quo finance.” And this idea is where I began to see more clearly how this might be connected to writing. (I apologize in advance to Mr. Waldman, who might well be horrified by what I’ve written in this post thus far and by how I plan to apply it.)

If we were to name literature’s most important use and/or historical effect (keeping in mind that I find the idea of writers as “the unacknowledged legislators of the world” basically laughable), we might consider the gradually widening circle of humanity. More people acknowledge more other people as valid human beings now than have ever done so in the past, and this trend will hopefully continue — and with it, a correlated decline in violence and warfare. One of the most important books in American history is easily Uncle Tom’s Cabin, not because it is very well-written or even especially humane, but because it was an effective persuasive tool for advancing the abolitionist cause. This is, aside from producing pleasure, what literature does best: it persuades us that other people exist, that they are valid and real, that they are worthy of our esteem.

This often takes the form of a sort of mystification. The story or poem describes the internal, subjective, and/or spiritual dimensions of a given character or speaker in a way that builds him or her up into a sort of “three-dimensional” construct: in religious traditions, this construct is ennobled by something like a soul, and in secular humanist traditions it will be something like dignity or innate value. By persuading us that our neighbors are nearly as valuable as we are, literature persuades us to invest energy in ourselves and each other by guaranteeing returns on our investments. (Civilization, fellow-feeling, spiritual fulfillment, moral goodness, etc.) We are persuaded to participate in the collective fiction of humanity, and we benefit from that fiction. There are any number of dubious claims at the heart of this fiction, some of which allow abuses like various essentially theocratic measures, but it’s a small price to pay for civilization, no?

Like Waldman, I suspect there are alternatives to misleading our readers and ourselves, though I do not believe we will generally pursue them. The risks in writing are small (a collapse of faith in literature would mean very little, and a new literature would arise to replace it seamlessly, or television would take over completely, which would be no great tragedy — whereas a collapse of faith in finance has unthinkable consequences for human welfare and so should not be risked lightly) but the psychological need for the comfort of collective fictions is more powerful still than the broader social need: as straightforward religion becomes less and less viable, would-be believers take solace in stories. Still, the case for investment in human welfare is strong, and while I am severely skeptical that any individual human being is invested with the slightest scrap of inherent anything, dignity or otherwise, we really do share dignity and beauty as a collective (as groups, as families, as friends, as communities). This is all to say that I think it is rational to behave as if we have individual rights and individual value, even if this is not strictly true — but that by blinding ourselves to what we are doing, by mystifying each other rather than honestly describing what we are choosing to do and why we are choosing to do it, we allow dire thefts and frauds both material and immaterial. (Consider the way the “great chain of being” both positions the entire human race in relationship to God [thus collectively ennobling humanity] and in relationship to the king [thus licensing the king to extract hideous rents from his subjects.]) (Consider the way that our collective fiction of the soul allows the bosses to promise us fulfillment in another world.)

What I love best in literature is writing that tries to grapple more honestly with these questions of value (what about humanity is worthy of our collective investment, and to what end?). These are both the most pleasurable words for me and the most useful. I am thinking here of Beckett, of Pynchon, of DeWitt, of Vonnegut, of (why not say it?) Shakespeare, of McCarthy, of many writers we talk about here every day. This post feels, especially now that I’ve dropped some names, hopelessly pretentious and too big for my particular britches, but hell, why not, we are here, this is something to think and to talk about.

I suspect there is some pretty basic lit theory addressing some of what I’m talking about here, and I fear on the other hand that what seems clear and obvious to me is hopelessly confused and confusing from an outside perspective, but at any rate I’m really curious to see what people think of these things, or adjacent issues. I am soliciting your response. Alone I am nothing. Together we are something beautiful.

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  1. 88888888888888888888888

      Of course we’re not speaking on behalf of all literature when we claim that it persuades us that other people exist, let alone are worthy of our esteem. Nor does all literature necessarily even attempt a 3-dimensional character-building or bring us any closer to a relatability to other people.

  2. Mike Meginnis

      No, of course not. Most mainstream literature of any real value does some of that work; a lot of it doesn’t. I listed some pretty well-known writers above who I see as not consistently part of that tradition.

  3. 88888888888888888888888

      It’s your wording a lot of the time that throws me off, and the point which I ultimately come to disagree with. You seem to favor qualitative terms with arbitrarily arrived-upon or entirely unfounded significance (like the above ‘literature of real value’).

      Aside from this, I think your claim that more people are recognizing other people as valid people than ever is intriguing. On the one hand, certainly (w/r/t human rights etc etc). On the other hand, with the ever-metastasizing virtual-based reality, I think we’re becoming more and more dehumanizing in our interactions.

  4. Mike Meginnis

      Yeah, fair enough. I’m not sure how to discuss these things without relying on squishy terminology! I can do my best to define anything you’d like to see defined (obviously literary value is a subjective question, but my thinking in my reply to you there is that if a story or a poem isn’t going to be legitimately “great,” which most mainstream writing won’t, then it can at least do some sort of beneficial political work, such as arguing for bland “inclusiveness” or etc.).

  5. Tim Horvath


      Very provocative. I like the thrust of thinking about the slanting of fiction and the relationship between emotional and cognitive investment and economic investment and the possible parallels between these. Without having read the whole Waldman post, but having skimmed it and read your summary, I think I find some fundamental problems with it. For one, it seems to assume that people are either risk-averse or risk-prone as types, rather than that people fluctuate depending in their risk-proneness based on many things, including their past experiences, the level of trust in the individuals with whom they are dealing, their assessment of what the potential rewards are, and many etceteras. Like, not to reduce things to biochemistry, but hormones can impact risk-taking behavior (or “modulate” it), and that’s not something that such an economic model accounts for.

      Anyway, I suppose I’m also suspicious of the idea that literary fiction is either honest or dishonest with respect to why we do what we do. Much as I love Shakespeare and McCarthy, eg., I’m skeptical of the idea that their “honesty” with respective to human motive is their primary virtue. I might argue that Shakespeare’s multitudinous scope, for instance, his panoramic sweep of human nature, which goes hand-in-hand with an anti-reductive attitude, is at the core of his achievement, a generosity and range encompassing both the conferring of dignity and the mockery of high and low. As for Blood Meridian, that’s complicated; its fusion of Biblical language and Nietzschean philosophy and anti-revisionist history is daunting, but again I’m not sure I’d say that honesty is its signature strength.

      What I might suggest is that fictionalizing itself is an inherent (yes, I’ll bite) part of being human, that it pervades our lives in a slew of ways, positive and corrupting, liberating and repressive, and that those writers who examine this fictionalizing tendency are themselves writers who I (and maybe you, given some of these overlapping instances, though I wouldn’t deign to speak for you) find more compelling.

      Thanks for stirring the waters. Cool post.

  6. deadgod

      I think Pollack’s “Flynn Effect” is undersold by Waldman:  complexity in economics and finance is somewhat due to the great number of clever people devoted to understanding economics and doing finance with both granular sensitivity and systemic comprehensiveness. 

      [Let me make a quick analogy with physics:  with respect to the tremendous complexity of particle and cosmological physical knowledge, it’s not that Newton wasn’t as smart as a super-competent 21st c. physicist, but rather, that there are dozens of ‘Newtons’ alive today, each brick-laying away at a part of an edifice much more intricate than what Newton built–amazingly ingenious as his contributions were (at a time when the ‘physics house’ was, compared to now, a hut).  I think a similar (historically) growing intricacy obtains in the case of, what, economic mechanics.]

      Opacity is different; it includes deliberate misdirection, and not simply ‘thought complicated in accordance with one’s experience of reality’.

      Transparency would expose risk; Waldman’s argument is that therefore opacity enables the risk-averse to take unanticipated risks in collectively beneficial ways.  –and maybe opacity has that counter-intuitive net-positive effect . . . but I think, if so, not much.

      Much more, transparency would expose exhorbitant handling ‘costs’ (what commenters on the thread call “rent cost”).  –and beyond-foolish risks (the undertaking of which would only benefit middlemen long-term).

      That part of opacity which is not due to actual transactional complexity seems to me to be the result of chicanery (and charlatanism–incompetence and intellectual overconfidence definitely contribute to “opacity”).

      Those on that comment thread that explain financial “opacity” in, eh, cynical terms seem to me to be dismayingly apt, however self-congratulatory their tones might sound.

  7. Guestagain

      risk in anything is a wager and banks rarely lose because as you stated, like a casino, they set the vigorish to maximize their cut, opacity and complexity increases in proportion to risk, reward, and failure/loss as confusion and the unknown are chemical compounds of risk, the greater risk, the less clarity and visibility into what can be statically measured as stillness is required to measure and confusion and the unknown are in motion, value that was once objectively performance based across the reporting timeframes of generally accepted accounting principals morphed, or some argue, mutated, into a radical hedge on the success, or radical failure-bets on future value that were desire-based, or emotionally centered from a herd mentality and will, so internet startups for example traded at many thousands of multiples over real/actual value, less a well planned conspiracy than a runaway train or tornado and it does seem like this whole vortex or inertia and its effects are being parallelized or represented in some contemporary literature

  8. deadgod

      You make an interesting analogy between Waldman’s explanation of the collective benefit of locally destructive financial opacity and storytellers “misleading” audiences by inflating the individual benefit of collective well-being (if I understand you correctly).

      I think the analogy breaks down in two ways.  First, Waldman’s discussion, while entertaining, isn’t, in my dilettante’s economic view, too useful – or even adequate.

      But I also think that storytelling, while it accomplishes – pretty intentionally – the socially cohering function you identify, also strengthens ‘life’ by challenging it on the individual level.  Homer, let’s say, doesn’t only deceive his audience by making it feel good about individual sacrifice for the common good (in an enlightenedly self-interested way); he also riles his audience, and makes its members feel lousy.

      Plato is right:  storytelling is dangerous.  –and he’s right in making Socrates dangerous to himself as well as to others:  storytelling should be dangerous–done right, dangerous living is good for your ‘soul’.

      There’s a word for storytelling that makes you happy when it’s beautiful–but, in that case, not “comfortable”:  tragedy.  Sometimes, when storytelling causes you to suffer, what you get is a direct intimation of reality.

      –and that is sometimes a benefit that comes from the same storytelling experience that knits a community together the way that Oedipus Tyrannos and, oh, The Great Gatsby might do.

      How does opacity in finance accomplish any sort of painfully strengthening self-confrontation?  –except when the bubble bursts, ha ha ha.

  9. Mike Meginnis

      Thanks for your thoughtful comments! To your first paragraph: my understanding is that people *generally* are risk-averse in economic terms. For instance, I can’t recall the specifics well enough to get the right figures but I think I’ve read about studies that demonstrated people didn’t like to risk something like losing $5 even if they had an equal chance of winning $10, even though taking the bet is in purely rational terms probably the right call (for the inverse of the reason playing the lottery is irrational even though the losses involved for a given player are so small: they’re still larger than your average winnings will be!). While you’re right that obviously there are complications that we can bring to this picture, the risk-hungry are only temporarily so, or they are freaks of nature, which is enough to get you an entrepreneur class (the true freaks of nature) and maybe a few angel investors but not a proper system for allocating capital or enough capital to allocate. In specific cases we can talk about the ways these things shift, but in aggregate my understanding is that risk aversion is the rule. Many people will find this claim ludicrous — why the meltdown, if Wall Street is so cautious? — but I’m persuaded by those who argue that the crisis happened in part because traders were desperate to convince themselves there was no risk at all. Thus the elaborate slicing and dicing to make everything rated AAA (or “risk free”). 

      And yes, to describe any fiction as “honest” and especially my preferred fiction is stacking the deck and probably silly. What I should say is that they better fit my particular vision of reality than do many others. Perhaps predictably, I can’t agree that anything is “inherent” in being human, except insofar as humanity itself is a linguistic construct and therefore cannot exist without the central fiction-building tendency (so, uh, I guess I’m saying I agree completely, but with a basically meaningless prelude).

  10. Mike Meginnis

      It seems to me that you, myself, and Waldman actually agree on much of the underlying reality of the situation, but with different emphasis (Flynn Effect aside; and I don’t have the expertise to say much there, though I suspect our intelligence is much less important than our ability to collectively develop inscrutable trading algorithms). He concedes that his description of the status quo is too flattering and that there are better ways to allocate capital, but that they would require a profound (and unlikely) transformation in finance. He agrees that there is egregious fraud, and he no doubt agrees that the various rents extracted by middle men are exorbitant. He makes it clear that the consequences of our current system have “profound, even apocalyptic social costs.” This is not a guy who thinks the current system is great! He just (presumably) thinks it’s better than the alternatives we’ve practiced in other places and times — a position I would generally agree with. We will always have corruption, and we need to design better ways of dealing with it and of organizing our resources as communities, but it seems perverse to me to insist on criminality and corruption as the central organizing forces of a system that has been such a force for real material increases in human welfare — an impulse that has more to do with the liberal love for frivolous purity contests than with actual plans to actually improve anything for anybody. (Yes, I think I may be HTMLGIANT’s only self-identified capitalist.)

  11. Mike Meginnis

      I actually think you’re saying here what I was saying above. Most literature, even most good literature, largely serves to comfort us and reassure us that humanity is the best thing ever. (Even and sometimes especially the literature that appears to challenge us is ultimately flattering; consider the way many stories will smugly congratulate reader and author alike for understanding what no one else does.) Some of it, though, challenges us and serves to demystify humanity (ourselves and others). This is the best stuff, and rather than asking us to invest in our community based on a shared guarantee of (probably false) worth, it challenges us to make the same decision to invest (a rational one!) based on a more realistic conception of who and what we are as individuals, and as communities. The analogy breaks down there intentionally: I’m saying that’s one of the primary differences between my ideal literature and the things I love less, analogous to Waldman’s idea of a fundamentally different means and understanding of finance.

  12. Tim Horvath

      I’ve heard about the same studies that you’re talking about, so that makes sense, people being more likely to avoid pain than they are to seek reward. I just think the notion of risk needs to be broadened beyond the game theory schematics which Waldman isolates. Context isn’t everything, but it’s a lot. But of course, that’s what literature is adept at, leaving the context intact, mapping it out in detail.

      In terms of placebos and self-deception, Robert Trivers, one of the great evolutionary psychologists, has a new book out called The Folly of Fools: The Logic of Deceit and Self-Deception in Human Life that looks like it could offer a lot to this discussion. I do tend to think that there are things that are inherently human, and that humanity is more than a linguistic construct; my thinking goes along the lines of, say, Brian Boyd’s On the Origin of Stories, but that’s a longer discussion. Although I do like the idea of humanity as a linguistic destruct in Ben Marcus’s new one. As for your stacking the deck with your choices–of course, yes! Aren’t we always doing this–guilty as anyone, myself–of finding explanations for why we feel invested in the books we do. A perfect illustration of your original point in action. So here I am, becoming more convinced…

  13. alex crowley

      Mike, who are these people that are arguing that traders were desperate to convince themselves? I’ve yet to hear anyone so deluded as to actually argue that position and mean it. said traders were desperate to convince others that their schemes were workable. personally, I’d consider that part of the “fraud” in Waldman’s [apologetic] schematic.

      while you’re correct to point out a generalized human risk aversion (I’ve also read such studies/reports), I don’t see why that necessitates our settling for the system as it currently stands. seems to me like Waldman is perpetuating the “con” that bankers (or, more accurately, their methods) are so necessary that without them our society would collapse. the only thing that would collapse is the system they run for themselves.

  14. Mike Meginnis

      It’s worth keeping in mind that there are quite a lot of traders, and many of them suffered tremendous losses as a result of the crash: that’s what makes it a crash, and that’s why investment has been so anemic since. Systemically and/or politically important people were bailed out, but that isn’t everybody, and a lot of people got fucked over. Moreover, I don’t think it requires an excessively charitable view of human nature to suspect that self-deception is more common than out-and-out malice. Begin with the premise that you are roughly average in terms of general goodness and honesty. Ask yourself whether you would be more likely to intentionally rip people off or to do it by way of self delusion. Adjust this likelihood by your honest assessment of the likelihood that the people in finance are significantly worse human beings than you not only in terms of their capacity for hubris and self-delusion, but in their willingness to actively deceive. (If I had to put a number on it, I would guess the people involved in these deals were maybe 10% worse, on average, than I am, as a human being.) I think an honest assessment will lead to the conclusion that self-delusion is the best explanation for a reasonable majority of what went wrong. (This theory of the crisis as largely driven by risk aversion has been advanced by a number of well-known writers; memory is imperfect here, but I believe Felix Salmon is one of them, Matt Yglesias another, maybe Brad DeLong and Ezra Klein. At any rate, certainly not a bunch of crackpots.)

      Waldman himself says in his original post that its description of the status quo is too generous and writes that the consequences of the current system’s failings are “near apocalyptic,” so he’s hardly saying the current system is awesome. He also writes that other solutions to these problems do exist, but that they would require massive transformations (and so, implicitly, they are very unlikely). My general feeling is that the current system is deeply flawed but better than any currently practicable alternatives, and that the left should focus its efforts on labor law reform, a stronger safety net, and blunt/simple regulations of the markets designed to minimize systemic risk, among other things.

  15. alex crowley

      I can agree maybe to a point. A few years ago I worked in real estate and had to quit because I sucked at trying to convince people to take shitty apartments and the like. Everyone around me was of the self-deluded sort you describe here. (at the risk[!] of sounding like a huge asshole, these folks weren’t particularly bright, but they were charismatic.) The couple who were good at what they did were purposefully manipulative and knew exactly what they were doing.

      So yes, those self-deluded “middleman” type people get hurt during collapses like the one we’re seeing, but it’s exactly the “Systemically and/or politically important people that got bailed out” who aren’t exactly hurting right now. They’re also the ones who devised the schemes that caused the collapse.

      Perhaps I’m missing some other point you’re trying to make? I also lost my train of thought.