Saturday, January 31, 2009

Joey Rothbard on the Rothard/Rand schism

In this audio recording, Joey Rothbard gives us a laugh-out-loud portrait of the Murray Rothbard/Objectivism schism, including the famous accusations of plagiarism directed at Rothbard.

(hat tip Neil Parille)

Saturday, January 24, 2009

Objectivism & Economics, Part 17

Laissez-faire as a rationalization for fraud. In her essay “The Nature of Government,” Ayn Rand wrote,
A unilateral breach of contract involves an indirect use of physical force: it consists, in essence, of one man receiving the material values, goods or services of another, then refusing to pay for them and thus keeping them by force (by mere physical possession), not by right—i.e., keeping them without the consent of their owner. Fraud involves a similarly indirect use of force: it consists of obtaining material values without their owner’s consent, under false pretenses or false promises.

We will ignore Rand’s odd decision to describe fraud as an “indirect use of physical force” and instead merely note that Rand opposed fraud. While we congratulate Rand for opposing fraud, nonetheless there are serious questions at to her willingness to effectively combat it. It is one thing to oppose fraud verbally; the real question is: What are you willing to do about it?

Alex Epstein and Yaron Brook attempt to answer this question when they write:
In an unfettered free market the desire for profit is satisfied by honest, long-range, rational behavior.... As for the real swindlers, existing laws against force and fraud are sufficient to protect us. If our politicians are indeed concerned about the stock market, let them demonstrate it by eliminating, not adding, regulations and making the market truly free.

Epstein and Brook would have us believe that enforcing “existing laws” is “sufficent” in the sempeternal war against fraud. Yet what does this mean? What specific laws are Epstein and Brook talking about? And why, in the very next sentence, do they insist on the elimination of regulations (that is, of laws) in order to make markets “free”?

One of the main goals of regulation is to increase the integrity and transparency of markets. As Charles Morris explains in Trillion Dollar Meltdown:
It is the transparency and integrity of American financial markets that has made them such a magnet for foreign investment… That hard-won reputation was, to a great extent, the consequence of generally superb American market regulations, epitomized by the SEC.

The American regulatory scheme is based on the insight that government can best support financial markets by ensuring that investors get accurate information…. After a quarter century of antiregulatory zealotry, however, and a parade of fiascos from the S&L crash through the Enrons and WorldComs … the credibility of that system, and with it the attractiveness of American markets, is at risk.

Naive intellectuals like Rand, Epstein and Brook apparently believe that, as long as they ennuciate their disapproval of fraud, they won’t have to worry about anyone using their laissez-faire ideology as a rationalization for crippling the ability of the government to combat fraud. Yet this is part of what happened in the current economic crisis. The deregulation of markets and hostility toward government oversight is an important factor in credit market meltdown of the last year. Many unscrupulous operators in the markets become anti-regulatory and laissez-faire zealots for the simple reason that they wish to do as they like, even if doing as they like means committing fraud. They use laissez-faire ideologies such as Rand’s to rationalize crippling the government’s ability to combat fraud.

While Rand and her disciplines may consider themselves opposed to fraud, they certainly do not appear particularly eager to prevent such abuses. Indeed, they seem to oppose many of the attempts on the part of the government to embattle fraud. Take, for example, Leonard Peikoff’s hostility toward the SEC. On his nineties radio show on KIEV in Los Angeles he stated his desire to see the SEC abolished and declared his approval for insider trading.

What Rand, Peikoff, and other Objectivists fail to understand how difficult it is to enforce laws against fraud. Not every act of fraud is easy to detect or, even when detected, easy to prove in a court of law. White collar criminals, in contradistinction to common street criminals, are usually very intelligent and are very good at hiding their tracks. Corporations in which criminal activity has occurred sometimes, out of embarrassment and fear of Stock Market repercussions, try to conceal the criminal act. Investigations and trials of corporate criminals are very complex and expensive. The complexity of market transactions can serve as cover for fraudulent activity—which is one of the reasons why the SEC tries to keep markets as transparent as possible. They also make government oversight a necessary component to government regulation of markets.

In the laissez-faire model embraced by Rand, the courts are assigned the function of protecting private property and contracts from “breach or fraud.” In other words, the primary (if not sole) weapon for combatting fraud is the lawsuit. Fraud would, presumably, under such a vision of things, become an entirely civil matter, which of course would make easier for fraudulent economic behavior, along with other acts of questionable honesty, to go unpunished. The government and its citizens would be powerless to deal with any types of fraud that are not easily identified by the courts. As any in depth analysis of the relevant economic facts would demonstrate, it is not possible to regulate economic action solely (or even primarily) through lawsuits. That would merely bring about a society sunk in a morass of legal pettifoggery.

The role of the government in combatting fraud must go well beyond the old laissez-faire model of property rights and “freedom of contract.” As F. A. Hayek expressed it in The Road to Serfdom:
To create conditions in which competition will be as effective as possible, to supplement it where it cannot be made effective, to provide services which, in the words of Adam Smith, “though they may be in the highest degree advantageous to a great society, are, however, of such a nature, that the profit could never repay the expense to any individual or small number of individuals”—these tasks provide, indeed, a wide and unquestioned field for state activity. In no system that could be rationally defended would the state just do nothing [beyond protecting property rights and enforcing contracts]. An effective competitive system needs an intelligently designed and continuously adjusted legal framework as much as any other. Even the most essential prerequisite of its proper functioning, the prevention of fraud and deception (including exploitation of ignorance), provides a great and by no means yet fully accomplished object of legislative activity.

Sunday, January 18, 2009

PARC: The Compleat Debunking

James Valliant's "The Passion of Ayn Rand's Critics" is to literary biography what "Plan 9 From Outer Space" was to cinema. Now the indefatigable Neil Parille has compiled his series of posts critiquing this uber-weird tome - which has become a kind of cultic litmus for Objectivism - into one essential essay. Parille concludes:
"Simply put, James Valliant's PARC is filed with erroneous readings of sources, poor research, double standards, dubious reasoning and a profound unwillingness to come to terms with evidence that undermines its case."
In other words, it is written according to Objectivism's standard operating procedure.

Thursday, January 15, 2009

Objectivism & Economics, Part 16

Dishonesty, cheating, and theft. A recent study by the Josephson Institute found that 30% of today’s teenagers admit to having shop lifted in the last two year; that 42% said they lie for monetary gain; that 83% confessed to lying to a parent about a significant issue; and 64% admit to cheating in school over the past year. This sort of behavior is not, unfortunately, confined to teenagers, but afflicts all of society. In 2004, U.S. companies lost $4.7 billion to shop lifting and employee theft.

Corporate fraud remains a huge problem, despite the burdens imposed by the Sarbanes-Oxley regulations. Private equity firms, for example, aggressively buy up companies on the pretext of making these enterprises more efficient, yet statistics demonstrate that far more looting goes on than “value creation.” Subprime lending often was spearheaded by predatory mortgage brokers who made big promises to unsophisticated borrows only to charge immense fees and high interest rates further on down the road. Many of the financial instruments spawned by hedge funds have the whiff of fraud about them. Bad debt is mixed with good debt to create collateralized mortgage obligations (CMOs) which are then sold with triple A ratings, the good debt being used to conceal the bad debt. Then we have all the big news items in the corporate world: Enron, WorldCom, Madoff, etc. It doesn’t make for a particularly edifying spectacle.

Various explanations are given for the rise of dishonesty, cheating, and theft in America. Some blame it on secularization; some on the “greed” and “over-competiveness” of free enterprise; some on the decadence and demoralization caused by living in a wealthy society; some on the failure to discipline and instill self-control in young people. What do orthodox Objectivists blame it on? Consider Alex Epstein’s and Yaron Brook’s take on corporate scandals:
The common explanation that "greed" is to blame makes no sense--the abuses in companies like Enron and WorldCom were not exercises in self-interest, but in self-destruction. The shareholders of these companies lost huge amounts of money thanks to corporate mismanagement--mismanagement reflected by plummeting stock prices long before any scandals broke. Why did they tolerate incompetence for so long?
The reason lies in existing regulations that prevent shareholders from acting in their own interest. Anti-hostile-takeover legislation (passed in 1968 and reinforced by a myriad of state regulations) has made it difficult and costly for shareholders to replace incompetent management, thus allowing bad managers to get rich while driving companies into the ground, à la Enron. Arcane regulations passed in the 1930s limit the ability of the most knowledgeable shareholders to be involved in the board and therefore in decision-making. For example, financial entities, such as pension funds, insurance companies and mutual funds that own large stock positions in corporations, are either prohibited or strongly discouraged by law from board participation. Bankers who possess the financial resources and knowledge to take large positions in companies and promote rational corporate governance (as J. P. Morgan did at the turn of the century) are not allowed to do so.

As would be expected, Epstein and Brook blame government regulation. Is there any merit in their claim? No, not much. Several problems immediately come to mind. Note the dates of the regulations mentioned: the 1930s and 1968. Forty years ago in one instance, over seventy in the other. If these regulations are the prime culprits behind the rise of corporate fraud in recent years, why didn’t they lead to more fraud when they originally passed?

Be that as it may, it is unlikely that government regulations play a major role in shareholder power. The corporation, by dividing ownership into bits and pieces, creates institutional incentives that effectively empower management at the expense of ownership. As Schumpeter put it:
The capitalist process, by substituting a mere parcel of shares for the walls of and the machines in a factory, takes the life out of the idea of property. It loosens the grip that once was so strong—the grip in the sense of the legal right and the sense that the holder of the title loses the will to fight, economically, physically, politically, for “his” factory and his control over it, to die if necessary on its steps.

If you are simply one owner among hundreds, you’re not likely to go any great lengths to defend your “interests.” Indeed, you probably won’t even know about the incompetence of management until it’s too late. After all, that is normally what corporate fraud is all about: to conceal incompetence in management by “cooking” the books.

Brook and Epstein also complain of “complex and contradictory rules” which “encourage bad accounting.” But is that really what happened with Arthur Anderson and other accounting firms that are guilty of fraudulent accounting? Not according to insiders.
One reason for [the failure of accounting] is the well-known problem of conflict of interest [writes Richard Bookstaber, the well known hedge fund manager]. Accountants have a financial incentive to be on the company’s good side so they can keep their mandate. This conflict was the main reason for the erosion in the quality of financial reports over the course of the 1990s.

Brook and Epstein insist that “Rational managers have an incentive to provide accurate information to shareholders--it establishes their credibility and reputation and allows them to raise capital when needed.” This observation, however, misses the point. The problem is that, in contemporary financial markets, the risks are so great and the rewards so immense that it is possible for a manager to make huge amount of money at first only to lose huge amounts later on. Corporate fraud often arises from trading strategies that make huge amounts of money in the short run only to lose huge amounts in the long run. If a brokerage firm that has reputation for making enormous profits hides recent losses, how is anyone to know that the managers are incompetent? Their record seems to state otherwise; and until the fraud is exposed, they will continue to be seen as brilliant. It’s only after the fraud is exposed and investors have lost billions of dollars that the market punishes the fraud. Yet by then it’s too late.

Brook and Epstein conclude:
In an unfettered free market the desire for profit is satisfied by honest, long-range, rational behavior: by innovating, by hiring the best employees, by selling quality products and by providing accurate information to the owners of the corporation--shareholders. As for short-range managers, the markets will not tolerate them. As for the real swindlers, existing laws against force and fraud are sufficient to protect us.

The issue is not whether markets tolerate “short-range managers.” Markets do in fact tolerate such managers in the short-run—but that gives the managers plenty of time to inflict serious damage on financial markets. And when these same “markets” punish such short-term strategies, the greatest victims are never the managers, but the shareholders and investors. In the end, we have to reject the notion that markets, by themselves, will make people honest. Whatever the cause of the epidemic of cheating, dishonesty, and thievery that afflicts our society, such behavior places capitalism at risk. To paraphrase Edmund Burke: It is ordained in the eternal constitution of things, that men of dishonest minds cannot be free. Their mendacity forges their fetters.

Thursday, January 08, 2009

Objectivism & Economics, Part 15

Schumpeter’s challenge. The economist Joseph Schumpeter created quite a stir in the forties when he warned that “the capitalist order tends to destroy itself.” Schumpeter issued this warning despite his belief in what he described as “the impressive economic and the still more impressive cultural achievement of the capitalist order and at the immense promise held out by both.” Capitalism would destroy itself because it would undermine its own “protecting strata” and “institutional framework.” One of the reasons he gave for this pessimistic assessment seems rather prescient in relation to the current economic crisis:
Capitalist activity, being essentially “rational,” tends to spread rational habits of mind and to destroy those loyalties and those habits of super- and subordination that are nevertheless essential for the efficient working of the institutionalized leadership of the producing plant: no social system can work which is based exclusively upon a network of free contracts between (legally) equal contracting parties and in which everyone is supposed to be guided by nothing except his own (short-run) utilitarian ends.

In one sentence Schumpeter has put his finger on the greatest flaw of capitalist order. Contrary to what Rand and her followers believe, “rational” self-interest is not an entirely benign psychological force. Rand’s faith in self-interest (and it is only a faith) is not warranted by the facts. In the first place, it is absurd to regard human desires and sentiments as rational. A desire or sentiment can only be criticized in reference to an opposing desire or sentiment. As Spinoza famously put it: “an emotion cannot be destroyed nor controlled except by a contrary and stronger emotion.” Consequently, rationality, as an ideal, can only apply to the means by which desires and sentiments are satisfied. Yet this is not all. Even if there were (per impossible) such a thing as a “rational end,” it is very doubtful that very many human beings would be interested in pursuing it. If we make history and experience our guide in such matters—and whatever guide could possibly lead us to the truth besides history and experience?—then we are forced to conclude that the majority of human beings are largely non-rational in their conduct and are probably not even capable of being rational about any issue in the least complex (as rational methods of analysis tend to break down when applied to complex situations). When Schumpeter talks about “rational” habits of mind, he is not writing in the Randian sense of the word. He means something more along the lines of rationalism—i.e., the belief that no doctrine is true unless it can be proved “verbally,” through clever patter and other exercises of blatant sophistry. As a consequence of this sort of perfervid rationalism, individuals no longer believe in “higher” values or “lofty” moral ideas. Short-term self-interest and “immediate gratification” become the main desideratum, with sophistry being brought in to give the whole thing a window dressing of moral justification.

We see this played out in the financial sector. The birth of complex financial instruments based on computer generated formulas has allowed finance capitalism to mask what ultimately amounts to a vast ponzi scheme which yields huge profits in the short-run but ends in bankruptcy and dishonor. This sort of finance capitalism fits into what is known as the “Minsky cycle”:
Firms participating in the early stages of the cycle typically are not leveraged; Minsky called them hedged firms because their cash receipts cover their cash outlays. The success of the first movers draws in additional players. Speculative firms then engage in leverage to the point where they must borrow to meet some of their interest payments—usually borrowing in short-term markets to finance higher-yielding long-term positions. None of this is irrational behavior; market players are chasing short-term gains, and some of them are getting very rich.

The final stages of the Minsky cycle arrive with a proliferation of Ponzi firms, which must borrow to meet all their interest payments, so their debt burden continuously increases. At some point, a disruptive event occurs, … and markets abruptly reprice—the further along in the cycle, the more violent the repricing. [Charles Morris, The Trillion Dollar Meltdown, p. 133-4]

In other words, what we find in the world of high finance is a system which, by giving individuals the hope of huge rewards in the short-run, encourages them to behave in a ways that are destructive in the long-run. It takes strength of character to resist such huge short-run gains. Unfortunately, the very success of capitalism tends to create a prosperous society that weakens the moral fibre of individuals. Add to this situation the tendency of individuals—particularly intelligent individuals—to cloak their real motives under a thick shroud of ingenious rationalizations (e.g., “portfolio theory,” the “efficient market hypothesis,” “laissez-faire” ideology, etc.), and we have all the elements required to create market failure leading to widespread and socially harmful externalities, as can be readily corroborated by examining the 2008-2009 financial crisis.

Tuesday, January 06, 2009


We noted this oddity back in 2007. No surprises how it turned out.

NEW YORK (AP) -- A construction official falsely billed $1.2 million for supplies not delivered to clean up a toxic ground zero skyscraper in exchange for cash, clothes and trips to the Caribbean, prosecutors said Tuesday.

Robert Chiarappa was the purchasing agent for the John Galt Corp., which was hired to clean up the former Deutsche Bank tower after it was heavily damaged in the 2001 terrorist attack on the World Trade Center across the street.

Monday, January 05, 2009

Objectivism & Economics, Part 14

Rand’s “objective” value theory. Austrian economics ascribes to what is called the “subjective value” theory:
An individual's actions and choices are based upon a unique value scale known only to that individual. It is this subjective valuation of goods that creates economic value. Like other economists, the Austrian does not judge or criticize these subjective values but instead takes them as given data.

For obvious reasons, Rand did not like this theory. In her essay on capitalism, she provided an “objective” theory of economic value to take its place. The difficulty with all such “objective” theories is that they tend to equate objective value with success in the market. Hence popular music, headed by Elvis Presley and the Beatles, is objectively superior to classical music, because it has sold a lot more recordings and grossed far more profits. The Bible is objectively more valuable than Atlas Shrugged because it has sold more copies and, presumably, netted a greater profit.

To get around this difficulty, Rand introduces a distinction between what she calls “philosophical” and “social” value. The free market value of goods and services, she grants, “does necessarily represent their philosophically objective value, but only their socially objective value, i.e., the sum of the individual judgments of all the men involved in trade at a given time, the sum of what they valued, in the context of their own life.”

If Rand’s “socially objective” value sounds suspiciously like the the subjective value theory, well, that’s because there is very little difference between the two. So in order to draw a larger contrast between the two theories of value, Rand introduces another distinction. She claims that what makes her “socially objective” value truly objective is the discipline of the market:

Within every category of goods and services offered on a free market, it is the purveyor of the best product at the cheapest price who wins the greatest financial rewards in that field—not automatically nor immediately nor by fiat, but by virtue of the free market, which teaches every participant to look for the objective best within the category of his own competence, and penalizes those who act on irrational considerations. [CUI, 24-25]

As with many of this Rand’s theories, this one only remains plausible if we ignore the many facts that fail to accord with it. One of the long lasting criticisms of capitalism is that, under its regimen, business are often forced to appeal to the lowest common denominator to survive. The tacky, the tasteless, the vulgar, the obscene often triumphs over products that, from an “objective” point of view, appear more useful and “edifying.”

As an example of this, consider the most popular non-free iphone application, a piece of software appropriately entitled “iFart mobile.” According to the iFart website, their application is “Ranked #1 in overall sales of all applications in the world.” The video below goes into greater detail:

As amusing as all this may be, one still wonders what sort of “objective” value, even of the “social” type, a product like iFart can possibly have. Obviously, it is little more than an “entertainment” product and shouldn’t be taken too seriously. But where is the “objective” value in such a thing, beyond the obviously subjective humor that some people find in it? Can we really say that iFart, within its category of goods and services offered on the free market, is the “best product and the cheapest price”? How can this be? Is it because it's the best flatulence imitating application for the iphone? Even if this were so, it still doesn’t answer the question why flatulence imitating iphone apps have more objective value than other iphone apps. Beyond mere success in the market, what objective value, established by human “reason,” can be attributed to iFart?

The iFart application merely skims the surface of what is wrong with any objective theory of economic value. One can think of many worse examples: e.g., what about all those astrology books that are sold every year? or the billions of dollars spent on internet porn? or “gangsta” rap? Where is the objective value in these horrors? Yet they all thrive in the market. It simply will not do to mix economics with morality. Economic value—that is, the values people actually pursue in the market (rather than the values they “ought” to pursue) cannot in any meaningful sense be regarded as “objective.” The Austrians show good sense in regarding economic value as subjective.