Root Cause of the Financial Collapse

Search for the Root Cause. As a financial systems IT manager, I believe in finding the “root cause” of any breakdown of a system. Since it began I have looked for a “root cause” of the Financial Collapse of 2008 through today.

In a 2010 blog post, I wrote about the Dismantling of the American Dream. But this only dealt with the tactical decisions that lead to the financial collapse. It always bugged me not to know how reasonable people believed these decisions served the greater good of society or more selfishly their own desires for short term gain with long-term stability.

In the last few years, I have read hundreds of books on

Throughout all of these, I looked for common themes, events or trends that I could trace back to the beginning. I kept asking myself: “What started all of this?” I felt either there was a mass conspiracy (unlikely) or mass-delusion based on some fundamental belief that fell apart.

One Core Erroneous Belief, I think, is the effectiveness of The Black-Scholes Model used to mathematically govern options prices over time as being a good thing for financial markets.

The key idea behind the derivation was to hedge perfectly the option by buying and selling the underlying asset in just the right way and consequently “eliminate risk.” As it turns out risk could be postponed, shifted and concentrated, but like any closed system, it is impossible to eliminate it.

From Theory to Practice. Invented in 1973, The Black-Scholes Model won the Nobel Prize for Economics in 1997. It won in that year because of its’ contribution to the then growing bubble of ever more sophisticated and opaque financial risk calculations.

All the following are abstractions of this same original proof:

  • Derivatives
  • hedge funds
  • mark-to-market
  • mortgage-backed securities
  • sub-prime lending
  • credit default swaps
  • collateralized-debt obligations
  • quants
  • flash crash
  • systemic risk
  • too-big-to-fail

Every one of the above is a direct descendant of the Black-Scholes Model. This model transformed a very human decision-making process about investments, capital and risk into a very inhuman mathematical computation that could not continue ad infinitum.

I am not “blaming” the formula or its’ originators. Like the atomic bomb, someone was going to invent this. The world has benefitted from its use short term. But like the arms race, I believe the Black-Scholes formula (and it’s derivations) has brought us to the point of mutually assured economic destruction through the riskless concentration of income and wealth in the top 1% of Americans and the world as a whole. And the king’s highway of the NYSE’s Jersey data center keeps the High-Frequency Traders (HFTs) banging in and out of positions more than a porn star. And similarly, the people getting it the worst barely feel the f’in they are getting.

Key to Financial Stability: The Middle Class. It is human decisions of a vibrant middle class that disperses risk throughout a population of rational economic actors. It dilutes gains and losses into a larger pool of people. It provides the chance for more people to make a little more money through good investment decisions and others to lose a little money as a penalty for bad investment decisions. Human decisions build the middle class and inhibit calculated-concentrations of wealth in those who possess the systems power to obtain it. Human decisions slow capital and keeps it from chasing the latest fraction of return anywhere in the world in a nano-second.

What we are seeing is a series of extreme financial transaction events. And I believe in this environment, a more standard t-distribution in place of Black-Scholes is a better basis for the valuation of options. That method requires the intervention of humans into the decision-making process for particular buys and sells.

Following again the nuclear weapons analogy, like the movie War Games (about a defense department computer system nearly starting a nuclear war), our future may largely be determined by how carefully we “unplug” some of the inhuman mathematical computations and re-introduce human decision-making with all its’ fragility, irrationality, and blessed randomness.

Same disclaimer from 2010 post. Through some bizarre twist of fate I am a part of and benefit from financial services work. Thankfully my employer is intensely focused on business ethics and doing the “right thing” not what makes the most money; those are not the same thing.

I appreciate and work very hard in my job and give money and time to as many causes as possible. Of all the lines on my taxes, Line 17 (charitable giving) is most important to me; far more important than my AGI.

My future is to demonstrate to my kids how to:

  • Reduce consumption
  • Maintain a skeptical awareness of their ego
  • Recognize media messages fueling consumerism
  • Travel internationally
  • Live frugally, simply and in peace (God willing)

Root Cause of Financial Crisis by Craig Burma is licensed under a Creative Commons Attribution 3.0 United States License.


Text from Chrysler’s Half-time Advertisement – Loved it.

Text from Chrysler “Halftime in America” Superbowl advertisement. Copyright. Chrysler and Weiden and Kennedy.

It’s halftime. 
Both teams are in their locker room discussing what they can do to win this game in the second half.
It’s halftime in America too. People are out of work and they’re hurting. And they’re all wondering what they’re going to do to make a comeback. And we’re all scared because this isn’t a game. 
The people of Detroit know a little something about this. They almost lost everything. But we all pulled together. Now Motor City is fighting again.
I’ve seen a lot of tough eras, a lot of downturns in my life, and times when we didn’t understand each other. It seems that we’ve lost our heart at times. The fog of division, discord and blame made it hard to see what lies ahead. But after those trials, we all rallied around what was right, and acted as one. 
Because that’s what we do. We find a way through tough times and if we can’t find a way then we’ll make one. All that matters now is what’s ahead, how do we come from behind, how do we come together, and how do we win. Detroit’s showing us it can be done.
And what’s true about them is true about all of us. This country can’t be knocked out with one punch. We get right back up again and when we do the world’s going to hear the roar of our engines. 
Yeah. It’s halftime America.
And our second half’s about to begin.

The Rules – Theirs and Ours

We talk about the rules as if they are on set all follow regardless of class; this is an aberration.

Elite play by THEIR rules; see Davos, World Bank, IMF and dig through to find their rule books; they are there.

These institutions, determine, institutionalize and (most importantly!!!) ensure enforcement of a different set of rules for us to live by that focuses on control and the continued riskless concentration of wealth. This will continue… for a time.

Good Case study link below

The way we will be. A simple but effective lesson in zero-sum economics. In the end I learned from this we can only control our desire for consumptive based standard of living. Control this, and anyone can earns the calm acceptance of what is ahead.

From Our Own Correspondent: Nigeria

Owen Bennett Jones introduces a special essay from Mark Doyle on Nigeria’s recent turmoil.

Open letter to Richard Cordray:

Congratulations on your appointment as the Director of the Consumer Financial Protection Bureau (CFPB). As a member of Financial Services Industry, I applaud your appointment.

I hope you consider 3 tests for what to focus on with consumer financial transactions.

Those areas that allow…

1) riskless concentrations of wealth are

2) structurally reinforced through law or policy that was

3) achieved through political influence (aka lobbying)

In short this means following the money back to the motivation and down through to the impact on consumers. Not an easy challenge in the post Citizens’ United World.

You have a LOT of boundaries, requiring watered-down “consensus” among other regulatory agencies. And I am aware there will be lawsuits charging you were illegitimately appointed (without Congress being formally out of session). I hope you vigorously exploit these attacks as public relations nightmares for your opposition “protecting those who seek to continue exploiting consumers.”

I hope you use 1) social 2) local and 3) national media to drive items into the light of public awareness. Two examples

The “digital soil” is well-prepared with the seeds of discontent. We need only a little accurate information about the shady practice to spread it virally into bad public relations for the company. And we all know bad PR is more effective than most perfectly written laws any day.

I hope you consider the example of Steroids in baseball. A little embarrassment goes a long way to modify the mass of human behavior. The baseball analogy is particularly helpful in that the players had no less greed than “Wall Street” to use nefarious means to achieve huge personal returns. And, like financial services, the more light is shown on a few bad actors, the more others will attempt to cover their tracks. They will make mistakes that will lead to easier identifications, more vigorous prosecutions and stronger civil and (hopefully) criminal penalties.

Finally, I hope you will consider studying Eliot Ness‘ use unique enforcement through existing regulations (tax codes) to gain ground more quickly. I hope you consider liberal use of the RICO Act whenever possible.

Anyway, lots to do and none of it easy, but I hope you and CFPB will succeed in improving consumers’ vital tools of transparency, understanding risk and competition to create the “invisible hand” in free markets envisioned by Adam Smith.

End of a chapter – back to regular programming

On the 2 month anniversary of Occupy Wallstreet’s launch, I end my association and mentioning it; it is a practical and time commitment decision. I still believe in the need to address risk-less concentration of wealth in the top 1% of the world. But I need to move on. Thanks to those who stayed friends with me during this time in my life.

I thank Adbusters for opening my eyes to this. I thank the April 6 movement in Egypt for providing the template and Frontline for connecting us to them. I am thankful to Kickstarter for helping the money begin to flow into this movement.

In the end, I have to devote all energy to my career and moreover to my boys (I am glad they now see why Dad tested camping out in the back yard learned hand-powered water filtration systems last Spring. I think it makes sense to them now). So now… back to our regular programming of techno-trends and life in general. Peace is the Way.

Critique of Dave Ramsey’s Critique of Occupy Wallstreet

Dave Ramsey’s dismissal of OWS is either him pandering to his base or he does not understand how history repeats itself.

The arc of history shows movements are always disorganized at the beginning. “They are not organized” is an unfortunate blind spot many have fallen victim to such as…

  • Aleric and the Goths were “not very organized” but they were more hungry than the Romans so they won out and sacked Rome.
  • 1517 When he could not ex-communicate him, Pope Leo X often paid early print journalists and town criers make fun of Martin Luther’s petulance and lack of respect for The Church
  • 1764 The Stamp act started the calls for United States’ Independence from England. The King at the time described their protests as the “whiny little babies. Telling them to “grow up” was a common refrain of the loyalists.
  • People wrote volumes about how disorganized the peoples’ revolution was in China; yet it succeeded wildly
  • 1930-33 Journalists joked about the terribly inept German National Socialists were in 1930-33 lead by a goofy man named Adolph Hitler. We all know how that turned out.
  • Most recently the April 6 movement in Egypt was smeared as small band of anarchists with no agenda.

None of these writers were wrong at the time for saying they were disorganized. They were wrong to believe that state would continue ad infinitum. The elites believe mass disorganization of the protesters will be their downfall; and they are right. It will be THEIR downfall because masses cannot be controlled through government or other mechanisms they have implemented to maintain order.

Intense discontent is never found in ONE ISSUE.

  • The Declaration of Independence indicted the King of England on 27 points,
  • Martin Luther had a whopping 95 theses.
  • Mein Kampf carefully pieced together 30+ concepts Hitler collected and argued in the German streets before his failed coup attempt and imprisonment.

With social media in hand, rants, objections, ideas and solutions are be promoted, refined, battled for, catching on, dying off and building a following much faster than any campaign or election. OWS will find their voice in the stew of ideas percolating through Zuccotti park and around the Country.  I am not in favor of socialism and am in fact scared this will be the result.

I believe the OWS and Tea Party will eventually join forces. They already agree on 1) no bail outs, 2) let chips fall where they may. I see them in the near future agreeing on the common position of

“Government does not work for us.”

and then the battle for power will really be joined.

Some selected rejections of Ramsey’s “Celebrate the Land of Opportunity” section

Dave Ramsey Quote:

“This is the greatest country on the planet, but even here, you’re not guaranteed wealth…”

Craig Burma Response:

Ummm Dave there are a lot of people in this country who are guaranteed exactly that. Institutions and government policies reinforce inter-generational wealth that is NOT up for grabs for the next generation. The unbelievably low inheritance taxes assure that.

Dave Ramsey Quote:

You are, however, guaranteed the freedom to make your life what you want it to be.

Craig Burma Response:

Their is more oppty here than almost anywhere, but only the 1% get to “make your life what you want it to be;” the other 99% fight it out for their table scraps.

Dave Ramsey Quote:

… when you build your life around your dreams and passions and hard work, you’re guaranteed the right to keep it. No one has the right to take it away from you

Craig Burma Response:

I think Jesus answers this one best Luke 12: “Watch out and guard yourself from 37 all types of greed, 38 because one’s life does not consist in the abundance of his possessions.” 12:16 He then 39 told them a parable: 40 “The land of a certain rich man produced 41 an abundant crop, 12:17 so 42 he thought to himself, 43 ‘What should I do, for I have nowhere to store my crops?’ 44 12:18 Then 45 he said, ‘I 46 will do this: I will tear down my barns and build bigger ones, and there I will store all my grain and my goods. 12:19 And I will say to myself, 47 “You have plenty of goods stored up for many years; relax, eat, drink, celebrate!”’ 12:20 But God said to him, ‘You fool! This very night your life 48 will be demanded back from 49 you, but who will get what you have prepared for yourself?’ 50 12:21 So it is with the one who stores up riches for himself, 51 but is not rich toward God.”

Dave Ramsey Quote:

So to summarize, I’m not very impressed at the moment. I’m not impressed by your temper fit. I’m not impressed at your lack of goals and focus. I’m not impressed by the fact that the only thing I see about your movement is ignorance, immaturity and envy. Grow up—and get a job.

Craig Burma Response:

Dave, over 40% of the people marching in OWS have a job and probably work much harder than you do. So get over yourself and stop labeling people. I see hotel workers union workers, and a lot of white collar folks too all working but knowing they are not getting very far in comparison to the 1% because the game is rigged.

Dave Ramsey Quote:

you’ll get to become the very thing you’re now protesting: rich people who actually earned their money.

Craig Burma Response:

1. Barely any of the 1% earned it first generation, to believe that shows your ignorance.

2. We do not want to be like you. Your pride blinds you from that fact.

3. We protest because it is morally reprehensible to have this concentration of wealth in this Country or any country

Finally, I hold you culpable for continuing the BIG LIE that a person’s lot in life is completely up to their will. If that were true, thousands of immigrants would be millionaires; they have worked harder for less most Americans. Electricians, house cleaners and nurses work a lot harder than all the Wall Street bankers but will never sniff at their kind of money. At least the Hindu Caste system has the decency to acknowledge the unfortunate reality of birth in the upper limits of your upward mobility. Instead you guilt people into believing if they had just worked harder or wanted it more, they could have made it.

I pray for sensible democratic reforms that restrain not the attainment of wealth, but rather the institutional mechanisms that allow for the riskless concentration of wealth and the corresponding disparity of the masses.

Bank Fees – Strategic Thinking

I believe this is how to think through the bank fees to their logical end.

The “unknown variable” in this is consumer behavior. Namely are we prepared to “vote with our wallets?”

Here is how I believe this will go forward…

  • The card “fees” were “baked in” before
  • Consumers did not have a CLUE they were being charged; now they will through monthly charges
  • Banks will “loosely collude” and try to stick monthly fees to users
  • Consumer behavior will move towards much more use of cash (Dave Ramsey will love this and claim credit for it, maybe)
  • These are “rational consumer” choices (hello Adam Smith’s invisible hand)
  • Bad news for McDonalds (30% higher ticket when ccard is used) but great news for Treasury (Deluxe checks)
  • People consume less when they use cash
  • Standard of living is simplified (uh oh Walmart, Costco and discount retailers)
  • Less consumer purchasing = more purchasing power
  • More purchasing power = a mild offset to future inflation ahead as our debt deepens and inflationary pressures rise

If you need proof of this, look at the retailers’ articles on amping up cash reserves from “store to drawer.”

Retailers are also scrambling to find ways to provide “soft incentives” for using their credit cards card use; not because of the fee cap (though they are cheering that as a HUGE windfall) but because people “spend more on plastic.”

So who wins and who loses really if consumers in fact, do, vote with their wallets (along with public opinion and far superior to individual voting) and begin to use a lot more cash.

Winners                                                              Losers               

Consumers                                                         Retailers

Treasury                                                             Banks

99% Price Sensitive Consumers                 1% Non-Price Sensitive Consumers

The banks are betting consumers will accept the fee and not change behavior.  40,000 people marching in 9 cities makes me believe there is a chance people will change.

The big banks may be the Smartest Guys in the room; but that is a small room and getting smaller by the day.