Blaming the Victim

I was chatting with a former regulator and he opened my eyes to an important perspective, so I am going to backpedal a little today. Admittedly, many have been harsh on those who gave money to Madoff for ignoring red flags and being suckered by the phenomenal "too good to be true" returns.

Madoff Update

Due to size and shock of this story, it has been all over the web and papers. The Wall Street Journal has an entire page devoted to it. This scandal is every bit as shocking and disruptive as Enron was. Because so much information is becoming available, I see no need to repeat everything the WSJ is reporting (visit their page, the source of the facts below). Instead, I'd like to summarize a few new facts and add a few questions of my own.

Madoff's Ponzi continued

The story just keeps getting more outrageous. The two senior employees who questioned Madoff and uncovered the fraud happen to be his sons. They then turned him in. Imagine their horror at discovering the almost 50-year old family business was a complete fraud? (That assumes they weren't part of it.)

"All just one big lie"

I am utterly shocked at this moment. Really. Though the details are few at this time, it appears Bernard Madoff was arrested today in a $50 billion Ponzi scheme. Madoff started a securities firm in 1960 and grew it by being innovative in the broker-dealer business. Some of his innovations were quite controversial at the time.

Velocity

We have had some spirited debate about inflation here at TLRB. One concept that keeps arising is that you can't have inflation without growth in the money supply. That is, prices are a function of dollars chasing goods. If the number of dollars grows faster than the amount stuff to buy with them, then prices rise. In a recent post, a commenter took me to task (which everyone is welcome to do) for saying "generally speaking, growing demand increases upward price pressures." I didn't respond in full because the length of the response is worthy of a post in itself, so here it is.

Fairness

One rather phenomenon we regularly brush up against is the concept of fairness. Take recent posts on executive compensation, GM or corporate jets for example. Comments and emails suggested that CEO's don't deserve such high compensation or the opinion that it is/isn't fair to bail/rescue Wall St. and not GM/Detroit. Words such as "deserve", "fair", "worth", and "right/wrong" all denote value judgements. But why should such emotional judgements impact economics where such things can be quantified?

It turns out that it has something to do with evolution. Recently, Austrian scientists tested the behavior of dogs in the presence of inequitable rewards. The scientists paired dogs trained to respond to the command "paw" (like "shake", the dog places its paw in the experimenter's hand on command). Each dog could see the bowl of rewards and the other dog. When one dog was rewarded with tasty sausages, but the other was not, the slighted dog started refusing to participate. The scientists concluded that even dogs "refuse to participate in cooperative problem-solving tasks if they witness a conspecific (another dog) obtaining a more attractive reward for the same effort."

In other experiments with capuchin monkeys, scientists used stones, grapes and cucumbers to test for aversion to inequality. When a stone was retrieved, a reward of either a cucumber slice or a grape was given. When the rewards were roughly equal, the monkeys continued to perform the task. If the rewards differed, the slighted monkey began to refuse to perform.

If individuals take what they can get, they are maximizing their resources and improving their situation. In economics, we call this goal "maximizing profit". So refusing cucumbers is "irrational". (Resisting a Wall St rescue despite it benefiting everyone, for example). But in a cooperative society, each individual needs to make sure they aren't being taken advantage of. Far from being irrational, refusing cooperation until rewards are acceptably equitable makes sense. According to the study, "This behavior makes monopolization of gains by dominant individuals a short-sighted strategy: in the long run, equitable outcomes produce benefits to both the dominant and the subordinate party."

Dividing the kill or refusing a cucumber is much different than $700 billion rescue packages. Even CEO pay isn't so simple since evolution programmed us to reject inequity for similar work. CEO roles are not equal to rank and file work, but they may seem that way when extreme circumstances dimish even great CEO performance. Yet the line must be drawn somewhere- regardless of effort, too great a disparity between rewards will produce discontent (and it is). We are wired by evolution to see the inequity in bailouts or CEO pay instinctually, but we aren't necessarily wired to see how the timing or form of our revolt can severely hurt us all.

Recession or Depression?

Frequently you hear the definition of a recession as "two consecutive quarters of negative growth in GDP". While this definition approximates the effects of a recession, it is too simplistic. The National Bureau of Economic Research, or NBER, is the arbiter of the business cycle. When they announce the start or end dates of a recession, those dates are considered the official start/end points of the economic contraction.

Corporate Jets

This is something that has been bothering me for a while. Recently the attention given to this matter has risen to a level worthy of discussion, so here it is: why are people so disgusted by corporate air travel? When GM, Ford and Chrysler CEOs went to Washington for hearings few weeks ago, no one could stop talking about the fact that they each took corporate jet to D.C. for the hearing. There was nothing but outrage and indignation at the fact that these execs were begging for money but were "wasting" tens of thousands on corporate air travel. How arrogant that they can't travel commercial along with the rest of us sacrificing peons without stock options. At the very least, don't they have a PR person whispering in their ear that it would look bad?