Why we need critical thinking

Jul 9 JDN 2460135

I can’t find it at the moment, but awhile ago I read a surprisingly compelling post on social media (I think it was Facebook, but it could also have been Reddit) questioning the common notion that we should be teaching more critical thinking in school.

I strongly believe that we should in fact be teaching more critical thinking in school—actually I think we should replace large chunks of the current math curriculum with a combination of statistics, economics and critical thinking—but it made me realize that we haven’t done enough to defend why that is something worth doing. It’s just become a sort of automatic talking point, like, “obviously you would want more critical thinking, why are you even asking?”

So here’s a brief attempt to explain why critical thinking is something that every citizen ought to be good at, and hence why it’s worthwhile to teach it in primary and secondary school.

Critical thinking, above all, allows you to detect lies. It teaches you to look past the surface of what other people are saying and determine whether what they are saying is actually true.

And our world is absolutely full of lies.

We are constantly lied to by advertising. We are constantly lied to by spam emails and scam calls. Day in and day out, people with big smiles promise us the world, if only we will send them five easy payments of $19.99.

We are constantly lied to by politicians. We are constantly lied to by religious leaders (it’s pretty much their whole job actually).

We are often lied to by newspapers—sometimes directly and explicitly, as in fake news, but more often in subtler ways. Most news articles in the mainstream press are true in the explicit facts they state, but are missing important context; and nearly all of them focus on the wrong things—exciting, sensational, rare events rather than what’s actually important and likely to affect your life. If newspapers were an accurate reflection of genuine risk, they’d have more articles on suicide than homicide, and something like one million articles on climate change for every one on some freak accident (like that submarine full of billionaires).

We are even lied to by press releases on science, which likewise focus on new, exciting, sensational findings rather than supported, established, documented knowledge. And don’t tell me everyone already knows it; just stating basic facts about almost any scientific field will shock and impress most of the audience, because they clearly didn’t learn this stuff in school (or, what amounts to the same thing, don’t remember it). This isn’t just true of quantum physics; it’s even true of economics—which directly affects people’s lives.

Critical thinking is how you can tell when a politician has distorted the views of his opponent and you need to spend more time listening to that opponent speak. Critical thinking could probably have saved us from electing Donald Trump President.

Critical thinking is how you tell that a supplement which “has not been evaluated by the FDA” (which is to say, nearly all of them) probably contains something mostly harmless that maybe would benefit you if you were deficient in it, but for most people really won’t matter—and definitely isn’t something you can substitute for medical treatment.

Critical thinking is how you recognize that much of the history you were taught as a child was a sanitized, simplified, nationalist version of what actually happened. But it’s also how you recognize that simply inverting it all and becoming the sort of anti-nationalist who hates your own country is at least as ridiculous. Thomas Jefferson was both a pioneer of democracy and a slaveholder. He was both a hero and a villain. The world is complicated and messy—and nothing will let you see that faster than critical thinking.

Critical thinking tells you that whenever a new “financial innovation” appears—like mortgage-backed securities or cryptocurrency—it will probably make obscene amounts of money for a handful of insiders, but will otherwise be worthless if not disastrous to everyone else. (And maybe if enough people had good critical thinking skills, we could stop the next “innovation” from getting so far!)

More widespread critical thinking could even improve our job market, as interviewers would no longer be taken in by the candidates who are best at overselling themselves, and would instead pay more attention to the more-qualified candidates who are quiet and honest.

In short, critical thinking constitutes a large portion of what is ordinarily called common sense or wisdom; some of that simply comes from life experience, but a great deal of it is actually a learnable skill set.

Of course, even if it can be learned, that still raises the question of how it can be taught. I don’t think we have a sound curriculum for teaching critical thinking, and in my more cynical moments I wonder if many of the powers that be like it that way. Knowing that many—not all, but many—politicians make their careers primarily from deceiving the public, it’s not so hard to see why those same politicians wouldn’t want to support teaching critical thinking in public schools. And it’s almost funny to me watching evangelical Christians try to justify why critical thinking is dangerous—they come so close to admitting that their entire worldview is totally unfounded in logic or evidence.

But at least I hope I’ve convinced you that it is something worthwhile to know, and that the world would be better off if we could teach it to more people.

The idiocy of the debt ceiling

Apr 23 JDN 2460058

I thought we had put this behind us. I guess I didn’t think the Republicans would stop using the tactic once they saw it worked, but I had hoped that the Democrats would come up with a better permanent solution so that it couldn’t be used again. But they did not, and here we are again: Republicans are refusing to raise the debt ceiling, we have now hit that ceiling, and we are running out of time before we have to start shutting down services or defaulting on debt. There are talks ongoing that may yet get the ceiling raised in time, but we’re now cutting it very close. Already the risk that we might default or do something crazy is causing turmoil in financial markets.

Because US Treasury bonds are widely regarded as one of the world’s most secure assets, and the US dollar is the most important global reserve currency, the entire world’s financial markets get disrupted every time there is an issue with the US national debt, and the debt ceiling creates such disruptions on the regular for no good reason.

I will try to offer some of my own suggestions for what to do here, but first, I want to make something very clear: The debt ceiling should not exist. I don’t think most people understand just how truly idiotic the entire concept of a debt ceiling is. It seems practically designed to make our government dysfunctional.

This is not like a credit card limit, where your bank imposes a limit on how much you can borrow based on how much they think you are likely to be able to repay. A lot of people have been making that analogy, and I can see why it’s tempting; but as usual, it’s important to remember that government debt is not like personal debt.

As I said some years ago, US government debt is about as close as the world is ever likely to come to a perfect credit market: with no effort at all, borrow as much as you want at low, steady interest rates, and everyone will always be sure that you will pay it back on time. The debt ceiling is a limit imposed by the government itself—it is not imposed by our creditors, who would be more than happy to lend us more.

Also, I’d like to remind you that some of the US national debt is owned by the US government itself (is that really even “debt”?) and most of what’s left is owned by US individuals or corporations—only about a third is owed to foreign powers. Here is a detailed breakdown of who owns US national debt.

There is no reason to put an arbitrary cap on the amount the US government can borrow. The only reason anyone is at all worried about a default on the US national debt is because of this stupid arbitrary cap. If it didn’t exist, they would simply roll over more Treasury bonds to make the payments and everything would run smoothly. And this is normally what happens, when the Republicans aren’t playing ridiculous brinkmanship games.

As it is, they could simply print money to pay it—and at this point, maybe that’s what needs to happen. Mint the Coin already: Mint a $1 trillion platinum coin and deposit it in the Federal Reserve, and there you go, you’ve paid off a chunk of the debt. Sometimes stupid problems require stupid solutions.

Aren’t there reasons to be worried about the government borrowing too much? Yes, a little. The amount of concern most people have about this is wildly disproportionate to the actual problem, but yes, there are legitimate concerns about high national debt resulting in high interest rates and eventually forcing us to raise taxes or cut services. This is a slow-burn, long-term problem that by its very nature would never require a sudden, immediate solution; but it is a genuine concern we should be aware of.

But here’s the thing: That’s a conversation we should be having when we vote on the budget. Whenever we pass a government budget, it already includes detailed projections of tax revenue and spending that yield precise, accurate forecasts of the deficit and the debt. If Republicans are genuinely concerned that we are overspending on certain programs, they should propose budget cuts to those programs and get those cuts passed as part of the budget.

Once a budget is already passed, we have committed to spend that money. It has literally been signed into law that $X will be spend on program Y. At that point, you can’t simply cut the spending. If you think we’re spending too much, you needed to say that before we signed it into law. It’s too late now.

I’m always dubious of analogies between household spending and government spending, but if you really want one, think of it this way: Say your credit card company is offering to raise your credit limit, and you just signed a contract for some home improvements that would force you to run up your credit card past your current limit. Do you call the credit card company and accept the higher limit, or not? If you don’t, why don’t you? And what’s your plan for paying those home contractors? Even if you later decide that the home improvements were a bad idea, you already signed the contract! You can’t just back out!

This is why the debt ceiling is so absurd: It is a self-imposed limit on what you’re allowed to spend after you have already committed to spending it. The only sensible thing to do is to raise the debt ceiling high enough to account for the spending you’ve already committed to—or better yet, eliminate the ceiling entirely.

I think that when they last had a majority in both houses, the Democrats should have voted to make the debt ceiling ludicrously high—say $100 trillion. Then, at least for the foreseeable future, we wouldn’t have to worry about raising it, and could just pass budgets normally like a sane government. But they didn’t do that; they only raised it as much as was strictly necessary, thus giving the Republicans an opening now to refuse to raise it again.

And that is what the debt ceiling actually seems to accomplish: It gives whichever political party is least concerned about the public welfare a lever they can pull to disrupt the entire system whenever they don’t get things the way they want. If you absolutely do not care about the public good—and it’s quite clear at this point that most of the Republican leadership does not—then whenever you don’t get your way, you can throw a tantrum that threatens to destabilize the entire global financial system.

We need to stop playing their game. Do what you have to do to keep things running for now—but then get rid of the damn debt ceiling before they can use it to do even more damage.

What happens when a bank fails

Mar 19 JDN 2460023

As of March 9, Silicon Valley Bank (SVB) has failed and officially been put into receivership under the FDIC. A bank that held $209 billion in assets has suddenly become insolvent.

This is the second-largest bank failure in US history, after Washington Mutual (WaMu) in 2008. In fact it will probably have more serious consequences than WaMu, for two reasons:

1. WaMu collapsed as part of the Great Recession, so there was already a lot of other things going on and a lot of policy responses already in place.

2. WaMu was mostly a conventional commercial bank that held deposits and loans for consumers, so its assets were largely protected by the FDIC, and thus its bankruptcy didn’t cause contagion the spread out to the rest of the system. (Other banks—shadow banks—did during the crash, but not so much WaMu.) SVB mostly served tech startups, so a whopping 89% of its deposits were not protected by FDIC insurance.

You’ve likely heard of many of the companies that had accounts at SVB: Roku, Roblox, Vimeo, even Vox. Stocks of the US financial industry lost $100 billion in value in two days.

The good news is that this will not be catastrophic. It probably won’t even trigger a recession (though the high interest rates we’ve been having lately potentially could drive us over that edge). Because this is commercial banking, it’s done out in the open, with transparency and reasonably good regulation. The FDIC knows what they are doing, and even though they aren’t covering all those deposits directly, they intend to find a buyer for the bank who will, and odds are good that they’ll be able to cover at least 80% of the lost funds.

In fact, while this one is exceptionally large, bank failures are not really all that uncommon. There have been nearly 100 failures of banks with assets over $1 billion in the US alone just since the 1970s. The FDIC exists to handle bank failures, and generally does the job well.

Then again, it’s worth asking whether we should really have a banking system in which failures are so routine.

The reason banks fail is kind of a dark open secret: They don’t actually have enough money to cover their deposits.

Banks loan away most of their cash, and rely upon the fact that most of their depositors will not want to withdraw their money at the same time. They are required to keep a certain ratio in reserves, but it’s usually fairly small, like 10%. This is called fractional-reserve banking.

As long as less than 10% of deposits get withdrawn at any given time, this works. But if a bunch of depositors suddenly decide to take out their money, the bank may not have enough to cover it all, and suddenly become insolvent.

In fact, the fear that a bank might become insolvent can actually cause it to become insolvent, in a self-fulfilling prophecy. Once depositors get word that the bank is about to fail, they rush to be the first to get their money out before it disappears. This is a bank run, and it’s basically what happened to SVB.

The FDIC was originally created to prevent or mitigate bank runs. Not only did they provide insurance that reduced the damage in the event of a bank failure; by assuring depositors that their money would be recovered even if the bank failed, they also reduced the chances of a bank run becoming a self-fulfilling prophecy.

Indeed, SVB is the exception that proves the rule, as they failed largely because their assets were mainly not FDIC insured.

Fractional-reserve banking effectively allows banks to create money, in the form of credit that they offer to borrowers. That credit gets deposited in other banks, which then go on to loan it out to still others; the result is that there is more money in the system than was ever actually printed by the central bank.

In most economies this commercial bank money is a far larger quantity than the central bank money actually printed by the central bank—often nearly 10 to 1. This ratio is called the money multiplier.

Indeed, it’s not a coincidence that the reserve ratio is 10% and the multiplier is 10; the theoretical maximum multiplier is always the inverse of the reserve ratio, so if you require reserves of 10%, the highest multiplier you can get is 10. Had we required 20% reserves, the multiplier would drop to 5.

Most countries have fractional-reserve banking, and have for centuries; but it’s actually a pretty weird system if you think about it.

Back when we were on the gold standard, fractional-reserve banking was a way of cheating, getting our money supply to be larger than the supply of gold would actually allow.

But now that we are on a pure fiat money system, it’s worth asking what fractional-reserve banking actually accomplishes. If we need more money, the central bank could just print more. Why do we delegate that task to commercial banks?

David Friedman of the Cato Institute had some especially harsh words on this, but honestly I find them hard to disagree with:

Before leaving the subject of fractional reserve systems, I should mention one particularly bizarre variant — a fractional reserve system based on fiat money. I call it bizarre because the essential function of a fractional reserve system is to reduce the resource cost of producing money, by allowing an ounce of reserves to replace, say, five ounces of currency. The resource cost of producing fiat money is zero; more precisely, it costs no more to print a five-dollar bill than a one-dollar bill, so the cost of having a larger number of dollars in circulation is zero. The cost of having more bills in circulation is not zero but small. A fractional reserve system based on fiat money thus economizes on the cost of producing something that costs nothing to produce; it adds the disadvantages of a fractional reserve system to the disadvantages of a fiat system without adding any corresponding advantages. It makes sense only as a discreet way of transferring some of the income that the government receives from producing money to the banking system, and is worth mentioning at all only because it is the system presently in use in this country.

Our banking system evolved gradually over time, and seems to have held onto many features that made more sense in an earlier era. Back when we had arbitrarily tied our central bank money supply to gold, creating a new money supply that was larger may have been a reasonable solution. But today, it just seems to be handing the reins over to private corporations, giving them more profits while forcing the rest of society to bear more risk.

The obvious alternative is full-reserve banking, where banks are simply required to hold 100% of their deposits in reserve and the multiplier drops to 1. This idea has been supported by a number of quite prominent economists, including Milton Friedman.

It’s not just a right-wing idea: The left-wing organization Positive Money is dedicated to advocating for a full-reserve banking system in the UK and EU. (The ECB VP’s criticism of the proposal is utterly baffling to me: it “would not create enough funding for investment and growth.” Um, you do know you can print more money, right? Hm, come to think of it, maybe the ECB doesn’t know that, because they think inflation is literally Hitler. There are legitimate criticisms to be had of Positive Money’s proposal, but “There won’t be enough money under this fiat money system” is a really weird take.)

There’s a relatively simple way to gradually transition from our current system to a full-reserve sytem: Simply increase the reserve ratio over time, and print more central bank money to keep the total money supply constant. If we find that it seems to be causing more problems than it solves, we could stop or reverse the trend.

Krugman has pointed out that this wouldn’t really fix the problems in the banking system, which actually seem to be much worse in the shadow banking sector than in conventional commercial banking. This is clearly right, but it isn’t really an argument against trying to improve conventional banking. I guess if stricter regulations on conventional banking push more money into the shadow banking system, that’s bad; but really that just means we should be imposing stricter regulations on the shadow banking system first (or simultaneously).

We don’t need to accept bank runs as a routine part of the financial system. There are other ways of doing things.

Maybe we should forgive student debt after all.

May 8 JDN 2459708

President Biden has been promising some form of student debt relief since the start of his campaign, though so far all he has actually implemented is a series of no-interest deferments and some improvements to the existing forgiveness programs. (This is still significant—it has definitely helped a lot of people with cashflow during the pandemic.) Actual forgiveness for a large segment of the population remains elusive, and if it does happen, it’s unclear how extensive it will be in either intensity (amount forgiven) or scope (who is eligible).

I personally had been fine with this; while I have a substantial loan balance myself, I also have a PhD in economics, which—theoretically—should at some point entitle me to sufficient income to repay those loans.

Moreover, until recently I had been one of the few left-wing people I know to not be terribly enthusiastic about loan forgiveness. It struck me as a poor use of those government funds, because $1.75 trillion is an awful lot of money, and college graduates are a relatively privileged population. (And yes, it is valid to consider this a question of “spending”, because the US government is the least liquidity-constrained entity on Earth. In lieu of forgiving $1.75 trillion in debt, they could borrow $1.75 trillion in debt and use it to pay for whatever they want, and their ultimate budget balance would be basically the same in each case.)

But I say all this in the past tense because Krugman’s recent column has caused me to reconsider. He gives two strong reasons why debt forgiveness may actually be a good idea.

The first is that Congress is useless. Thanks to gerrymandering and the 40% or so of our population who keeps electing Republicans no matter how crazy they get, it’s all but impossible to pass useful legislation. The pandemic relief programs were the exception that proves the rule: Somehow those managed to get through, even though in any other context it’s clear that Congress would never have approved any kind of (non-military) program that spent that much money or helped that many poor people.

Student loans are the purview of the Department of Education, which is entirely under control of the Executive Branch, and therefore, ultimately, the President of the United States. So Biden could forgive student loans by executive order and there’s very little Congress could do to stop him. Even if that $1.75 trillion could be better spent, if it wasn’t going to be anyway, we may as well use it for this.

The second is that “college graduates” is too broad a category. Usually I’m on guard for this sort of thing, but in this case I faltered, and did not notice the fallacy of composition so many labor economists were making by lumping all college grads into the same economic category. Yes, some of us are doing well, but many are not. Within-group inequality matters.

A key insight here comes from carefully analyzing the college wage premium, which is the median income of college graduates, divided by the median income of high school graduates. This is an estimate of the overall value of a college education. It’s pretty large, as a matter of fact: It amounts to something like a doubling of your income, or about $1 million over one’s whole lifespan.

From about 1980-2000, wage inequality grew about as fast as today, and the college wage premium grew even faster. So it was plausible—if not necessarily correct—to believe that the wage inequality reflected the higher income and higher productivity of college grads. But since 2000, wage inequality has continued to grow, while the college wage premium has been utterly stagnant. Thus, higher inequality can no longer (if it ever could) be explained by the effects of college education.

Now some college graduates are definitely making a lot more money—such as those who went into finance. But it turns out that most are not. As Krugman points out, the 95^th percentile of male college grads has seen a 25% increase in real (inflation-adjusted) income in the last 20 years, while the median male college grad has actually seen a slight decrease. (I’m not sure why Krugman restricted to males, so I’m curious how it looks if you include women. But probably not radically different?)

I still don’t think student loan forgiveness would be the best use of that (enormous sum of) money. But if it’s what’s politically feasible, it definitely could help a lot of people. And it would be easy enough to make it more progressive, by phasing out forgiveness for graduates with higher incomes.

And hey, it would certainly help me, so maybe I shouldn’t argue too strongly against it?

Cryptocurrency and its failures

Jan 30 JDN 2459620

It started out as a neat idea, though very much a solution in search of a problem. Using encryption, could we decentralize currency and eliminate the need for a central bank?

Well, it’s been a few years now, and we have now seen how well that went. Bitcoin recently crashed, but it has always been astonishingly volatile. As a speculative asset, such volatility is often tolerable—for many, even profitable. But as a currency, it is completely unbearable. People need to know that their money will be a store of value and a medium of exchange—and something that changes price one minute to the next is neither.

Some of cryptocurrency’s failures have been hilarious, like the ill-fated island called [yes, really] “Cryptoland”, which crashed and burned when they couldn’t find any investors to help them buy the island.

Others have been darkly comic, but tragic in their human consequences. Chief among these was the failed attempt by El Salvador to make Bitcoin an official currency.

At the time, President Bukele justified it by an economically baffling argument: Total value of all Bitcoin in the world is $680 billion, therefore if even 1% gets invested in El Salvador, GDP will increase by $6.8 billion, which is 25%!

First of all, that would only happen if 1% of all Bitcoin were invested in El Salvador each year—otherwise you’re looking at a one-time injection of money, not an increase in GDP.

But more importantly, this is like saying that the total US dollar supply is $6 trillion, (that’s physically cash; the actual money supply is considerably larger) so maybe by dollarizing your economy you can get 1% of that—$60 billion, baby! No, that’s not how any of this works. Dollarizing could still be a good idea (though it didn’t go all that well in El Salvador), but it won’t give you some kind of share in the US economy. You can’t collect dividends on US GDP.

It’s actually good how El Salvador’s experiment in bitcoin failed: Nobody bought into it in the first place. They couldn’t convince people to buy government assets that were backed by Bitcoin (perhaps because the assets were a strictly worse deal than just, er, buying Bitcoin). So the human cost of this idiotic experiment should be relatively minimal: It’s not like people are losing their homes over this.

That is, unless President Bukele doubles down, which he now appears to be doing. Even people who are big fans of cryptocurrency are unimpressed with El Salvador’s approach to it.

It would be one thing if there were some stable cryptocurrency that one could try pegging one’s national currency to, but there isn’t. Even so-called stablecoins are generally pegged to… regular currencies, typically the US dollar but also sometimes the Euro or a few other currencies. (I’ve seen the Australian Dollar and the Swiss Franc, but oddly enough, not the Pound Sterling.)

Or a country could try issuing its own cryptocurrency, as an all-digital currency instead of one that is partly paper. It’s not totally clear to me what advantages this would have over the current system (in which most of the money supply is bank deposits, i.e. already digital), but it would at least preserve the key advantage of having a central bank that can regulate your money supply.

But no, President Bukele decided to take an already-existing cryptocurrency, backed by nothing but the whims of the market, and make it legal tender. Somehow he missed the fact that a currency which rises and falls by 10% in a single day is generally considered bad.

Why? Is he just an idiot? I mean, maybe, though Bukele’s approval rating is astonishingly high. (And El Salvador is… mostly democratic. Unlike, say, Putin’s, I think these approval ratings are basically real.) But that’s not the only reason. My guess is that he was gripped by the same FOMO that has gripped everyone else who evangelizes for Bitcoin. The allure of easy money is often irresistible.

Consider President Bukele’s position. You’re governing a poor, war-torn country which has had economic problems of various types since its founding. When the national currency collapsed a generation ago, the country was put on the US dollar, but that didn’t solve the problem. So you’re looking for a better solution to the monetary doldrums your country has been in for decades.

You hear about a fancy new monetary technology, “cryptocurrency”, which has all the tech people really excited and seems to be making tons of money. You don’t understand a thing about it—hardly anyone seems to, in fact—but you know that people with a lot of insider knowledge of technology and finance are really invested in it, so it seems like there must be something good here. So, you decide to launch a program that will convert your country’s currency from the US dollar to one of these new cryptocurrencies—and you pick the most famous one, which is also extremely valuable, Bitcoin.

Could cryptocurrencies be the future of money, you wonder? Could this be the way to save your country’s economy?

Despite all the evidence that had already accumulated that cryptocurrency wasn’t working, I can understand why Bukele would be tempted by that dream. Just as we’d all like to get free money without having to work, he wanted to save his country’s economy without having to implement costly and unpopular reforms.

But there is no easy money. Not really. Some people get lucky; but they ultimately benefit from other people’s hard work.

The lesson here is deeper than cryptocurrency. Yes, clearly, it was a dumb idea to try to make Bitcoin a national currency, and it will get even dumber if Bukele really does double down on it. But more than that, we must all resist the lure of easy money. If it sounds too good to be true, it probably is.

Finance is the commodification of trust

Jul 18 JDN 2459414

What is it about finance?

Why is it that whenever we have an economic crisis, it seems to be triggered by the financial industry? Why has the dramatic rise in income and wealth inequality come in tandem with a rise in finance as a proportion of our economic output? Why are so many major banks implicated in crimes ranging from tax evasion to money laundering for terrorists?

In other words, why are the people who run our financial industry such utter scum? What is it about finance that it seems to attract the very worst people on Earth?

One obvious answer is that it is extremely lucrative: Incomes in the financial industry are higher than almost any other industry. Perhaps people who are particularly unscrupulous are drawn to the industries that make the most money, and don’t care about much else. But other people like making money too, so this is far from a full explanation. Indeed, incomes for physicists are comparable to those of Wall Street brokers, yet physicists rarely seem to be implicated in mass corruption scandals.

I think there is a deeper reason: Finance is the commodification of trust.

Many industries sell products, physical artifacts like shirts or televisions. Others sell services like healthcare or auto repair, which involve the physical movement of objects through space. Information-based industries are a bit different—what a software developer or an economist sells isn’t really a physical object moving through space. But then what they are selling is something more like knowledge—information that can be used to do useful things.

Finance is different. When you make a loan or sell a stock, you aren’t selling a thing—and you aren’t really doing a thing either. You aren’t selling information, either. You’re selling trust. You are making money by making promises.

Most people are generally uncomfortable with the idea of selling promises. It isn’t that we’d never do it—but we’re reluctant to do it. We try to avoid it whenever we can. But if you want to be successful in finance, you can’t have that kind of reluctance. To succeed on Wall Street, you need to be constantly selling trust every hour of every day.

Don’t get me wrong: Certain kinds of finance are tremendously useful, and we’d be much worse off without them. I would never want to get rid of government bonds, auto loans or home mortgages. I’m actually pretty reluctant to even get rid of student loans, despite the large personal benefits I would get if all student loans were suddenly forgiven. (I would be okay with a system like Elizabeth Warren’s proposal, where people with college degrees pay a surtax that supports free tuition. The problem with most proposals for free college is that they make people who never went to college pay for those who did, and that seems unfair and regressive to me.)

But the Medieval suspicion against “usury“—the notion that there is something immoral about making money just from having money and making promises—isn’t entirely unfounded. There really is something deeply problematic about a system in which the best way to get rich is to sell commodified packages of trust, and the best way to make money is to already have it.

Moreover, the more complex finance gets, the more divorced it becomes from genuinely necessary transactions, and the more commodified it becomes. A mortgage deal that you make with a particular banker in your own community isn’t particularly commodified; a mortgage that is sliced and redistributed into mortgage-backed securities that are sold anonymously around the world is about as commodified as anything can be. It’s rather like the difference between buying a bag of apples from your town farmers’ market versus ordering a barrel of apple juice concentrate. (And of course the most commodified version of all is the financial one: buying apple juice concentrate futures.)

Commodified trust is trust that has lost its connection to real human needs. Those bankers who foreclosed on thousands of mortgages (many of them illegally) weren’t thinking about the people they were making homeless—why would they, when for them those people have always been nothing more than numbers on a spreadsheet? Your local banker might be willing to work with you to help you keep your home, because they see you as a person. (They might not for various reasons, but at least they might.) But there’s no reason for HSBC to do so, especially when they know that they are so rich and powerful they can get away with just about anything (have I mentioned money laundering for terrorists?).

I don’t think we can get rid of finance. We will always need some mechanism to let people who need money but don’t have it borrow that money from people who have it but don’t need it, and it makes sense to have interest charges to compensate lenders for the time and risk involved.

Yet there is much of finance we can clearly dispense with. Credit default swaps could simply be banned, and we’d gain much and lose little. Credit default swaps are basically unregulated insurance, and there’s no reason to allow that. If banks need insurance, they can buy the regulated kind like everyone else. Those regulations are there for a reason. We could ban collateralized debt obligations and similar tranche-based securities, again with far more benefit than harm. We probably still need stocks and commodity futures, and perhaps also stock options—but we could regulate their sale considerably more, particularly with regard to short-selling. Banking should be boring.

Some amount of commodification may be inevitable, but clearly much of what we currently have could be eliminated. In particular, the selling of loans should simply be banned. Maybe even your local banker won’t ever really get to know you or care about you—but there’s no reason we have to allow them to sell your loan to some bank in another country that you’ve never even heard of. When you make a deal with a bank, the deal should be between you and that bank—not potentially any bank in the world that decides to buy the contract at any point in the future. Maybe we’ll always be numbers on spreadsheets—but at least we should be able to choose whose spreadsheets.

If banks want more liquidity, they can borrow from other banks—themselves, taking on the risk themselves. A lending relationship is built on trust. You are free to trust whomever you choose; but forcing me to trust someone I’ve never met is something you have no right to do.

In fact, we might actually be able to get rid of banks—credit unions have a far cleaner record than banks, and provide nearly all of the financial services that are genuinely necessary. Indeed, if you’re considering getting an auto loan or a home mortgage, I highly recommend you try a credit union first.

For now, we can’t simply get rid of banks—we’re too dependent on them. But we could at least acknowledge that banks are too powerful, they get away with far too much, and their whole industry is founded upon practices that need to be kept on a very tight leash.

What if everyone owned their own home?

Mar 14 JDN 2459288

In last week’s post I suggested that if we are to use the term “gentrification”, it should specifically apply to the practice of buying homes for the purpose of renting them out.

But don’t people need to be able to rent homes? Surely we couldn’t have a system where everyone always owned their own home?

Or could we?

The usual argument for why renting is necessary is that people don’t want to commit to living in one spot for 15 or 30 years, the length of a mortgage. And this is quite reasonable; very few careers today offer the kind of stability that lets you commit in advance to 15 or more years of working in the same place. (Tenured professors are one of the few exceptions, and I dare say this has given academic economists some severe blind spots regarding the costs and risks involved in changing jobs.)

But how much does renting really help with this? One does not rent a home for a few days or even few weeks at a time. If you are staying somewhere for an interval that short, you generally room with a friend or pay for a hotel. (Or get an AirBNB, which is sort of intermediate between the two.)

One only rents housing for months at a time—in fact, most leases are 12-month leases. But since the average time to sell a house is 60-90 days, in what sense is renting actually less of a commitment than buying? It feels like less of a commitment to most people—but I’m not sure it really is less of a commitment.

There is a certainty that comes with renting—you know that once your lease is up you’re free to leave, whereas selling your house will on average take two or three months, but could very well be faster or slower than that.

Another potential advantage of renting is that you have a landlord who is responsible for maintaining the property. But this advantage is greatly overstated: First of all, if they don’t do it (and many surely don’t), you actually have very little recourse in practice. Moreover, if you own your own home, you don’t actually have to do all the work yourself; you could pay carpenters and plumbers and electricians to do it for you—which is all that most landlords were going to do anyway.

All of the “additional costs” of owning over renting such as maintenance and property taxes are going to be factored into your rent in the first place. This is a good argument for recognizing that a $1000 mortgage payment is not equivalent to a $1000 rent payment—the rent payment is all-inclusive in a way the mortgage is not. But it isn’t a good argument for renting over buying in general.

Being foreclosed on a mortgage is a terrible experience—but surely no worse than being evicted from a rental. If anything, foreclosure is probably not as bad, because you can essentially only be foreclosed for nonpayment, since the bank only owns the loan; landlords can and do evict people for all sorts of reasons, because they own the home. In particular, you can’t be foreclosed for annoying your neighbors or damaging the property. If you own your home, you can cut a hole in a wall any time you like. (Not saying you should necessarily—just that you can, and nobody can take your home away for doing so.)

I think the primary reason that people rent instead of buying is the cost of a down payment. For some reason, we have decided as a society that you should be expected to pay 10%-20% of the cost of a home up front, or else you never deserve to earn any equity in your home whatsoever. This is one of many ways that being rich makes it easier to get richer—but it is probably the most important one holding back most of the middle class of the First World.

And make no mistake, that’s what this is: It’s a social norm. There is no deep economic reason why a down payment needs to be anything in particular—or even why down payments in general are necessary.

There is some evidence that higher down payments are associated with less risk of default, but it’s not as strong as many people seem to think. The big HUD study on the subject found that one percentage point of down payment reduces default risk by about as much as 5 points of credit rating: So you should prefer to offer a mortgage to someone with an 800 rating and no down payment than someone with a 650 rating and a 20% down payment.

Also, it’s not as if mortgage lenders are unprotected from default (unlike, say, credit card lenders). Above all, they can foreclose on the house. So why is it so important to reduce the risk of default in the first place? Why do you need extra collateral in the form of a down payment, when you’ve already got an entire house of collateral?

It may be that this is actually a good opportunity for financial innovation, a phrase that should in general strike terror in one’s heart. Most of the time “financial innovation” means “clever ways of disguising fraud”. Previous attempts at “innovating” mortgages have resulted in such monstrosities as “interest-only mortgages” (a literal oxymoron, since by definition a mortgage must have a termination date—a date at which the debt “dies”), “balloon payments”, and “adjustable rate mortgages”—all of which increase risk of default while as far as I can tell accomplishing absolutely nothing. “Subprime” lending created many excuses for irresponsible or outright predatory lending—and then, above all, securitization of mortgages allowed banks to offload the risk they had taken on to third parties who typically had no idea what they were getting.

Volcker was too generous when he said that the last great financial innovation was the ATM; no, that was an innovation in electronics (and we’ve had plenty of those). The last great financial innovation I can think of is the joint-stock corporation in the 1550s. But I think a new type of mortgage contract that minimizes default risk without requiring large up-front payments might actually qualify as a useful form of financial innovation.

It would also be useful to have mortgages that make it easier to move, perhaps by putting payments on hold while the home is up for sale. That way people wouldn’t have to make two mortgage payments at once as they move from one place to another, and the bank will see that money eventually—paid for by new buyer and their mortgage.

Indeed, ideally I’d like to eliminate foreclosure as well, so that no one has to be kicked out of their homes. How might we do that?

Well, as a pandemic response measure, we should have simply instituted a freeze on all evictions and foreclosures for the duration of the pandemic. Some states did, in fact—but many didn’t, and the federal moratoria on evictions were limited. This is the kind of emergency power that government should have, to protect people from a disaster. So far it appears that the number of evictions was effectively reduced from tens of millions to tens of thousands by these measures—but evicting anyone during a pandemic is a human rights violation.

But as a long-term policy, simply banning evictions wouldn’t work. No one would want to lend out mortgages, knowing that they had no recourse if the debtor stopped paying. Even buyers with good credit might get excluded from the market, since once they actually received the house they’d have very little incentive to actually make their payments on time.

But if there are no down payments and no foreclosures, that means mortgage lenders have no collateral. How are they supposed to avoid defaults?

One option would be wage garnishment. If you have the money and are simply refusing to pay it, the courts could simply require your employer to send the money directly to your creditors. If you have other assets, those could be garnished as well.

And what if you don’t have the money, perhaps because you’re unemployed? Well, then, this isn’t really a problem of incentives at all. It isn’t that you’re choosing not to pay, it’s that you can’t pay. Taking away such people’s homes would protect banks financially, but at a grave human cost.

One option would be to simply say that the banks should have to bear the risk: That’s part of what their huge profits are supposed to be compensating them for, the willingness to take on risks others won’t. The main downside here is the fact that it would probably make it more difficult to get a mortgage and raise the interest rates that you would need to pay once you do.

Another option would be some sort of government program to make up the difference, by offering grants or guaranteed loans to homeowners who can’t afford to pay their mortgages. Since most such instances are likely to be temporary, the government wouldn’t be on the hook forever—just long enough for people to get back on their feet. Here the downside would be the same as any government spending: higher taxes or larger budget deficits. But honestly it probably wouldn’t take all that much; while the total value of all mortgages is very large, only a small portion are in default at any give time. Typically only about 2-4% of all mortgages in the US are in default. Even 4% of the $10 trillion total value of all US mortgages is about $400 billion, which sounds like a lot—but the government wouldn’t owe that full amount, just whatever portion is actually late. I couldn’t easily find figures on that, but I’d be surprised if it’s more than 10% of the total value of these mortgages that would need to be paid by the government. $40 billion is about 1% of the annual federal budget.

Reforms to our healthcare system would also help tremendously, as medical expenses are a leading cause of foreclosure in the United States (and literally nowhere else—every other country with the medical technology to make medicine this expensive also has a healthcare system that shares the burden). Here there is virtually no downside: Our healthcare system is ludicrously expensive without producing outcomes any better than the much cheaper single-payer systems in Canada, the UK, and France.

All of this sounds difficult and complicated, I suppose. Some may think that it’s not worth it. But I believe that there is a very strong moral argument for universal homeownership and ending eviction: Your home is your own, and no one else’s. No one has a right to take your home away from you.

This is also fundamentally capitalist: It is the private ownership of capital by its users, the acquisition of wealth through ownership of assets. The system of landlords and renters honestly doesn’t seem so much capitalist as it does feudal: We even call them “lords”, for goodness’ sake!

As an added bonus, if everyone owned their own homes, then perhaps we wouldn’t have to worry about “gentrification”, since rising property values would always benefit residents.

What happened with GameStop?

Feb 7 JDN 2459253

No doubt by now you’ve heard about the recent bubble in GameStop stock that triggered several trading stops, nearly destroyed a hedge fund, and launched a thousand memes. What really strikes me about this whole thing is how ordinary it is: This is basically the sort of thing that happens in our financial markets all the time. So why are so many people suddenly paying so much attention to it?

There are a few important ways this is unusual: Most importantly, the bubble was triggered by a large number of middle-class people investing small amounts, rather than by a handful of billionaires or hedge funds. It’s also more explicitly collusive than usual, with public statements in writing about what stocks are being manipulated rather than hushed whispers between executives at golf courses. Partly as a consequence of these, the response from the government and the financial industry has been quite different as well, trying to halt trading and block transactions in a way that they would never do if the crisis had been caused by large financial institutions.

If you’re interested in the technical details of what happened, what a short squeeze is and how it can make a hedge fund lose enormous amounts of money unexpectedly, I recommend this summary by KQED. But the gist of it is simple enough: Melvin Capital placed huge bets that GameStop stock would fall in price, and a coalition of middle-class traders coordinated on Reddit to screw them over by buying a bunch of GameStop stock and driving up the price. It worked, and now Melvin Capital lost something on the order of $3-5 billion in just a few days.

The particular kind of bet they placed is called a short, and it’s a completely routine practice on Wall Street despite the fact that I could never quite understand why it is a thing that should be allowed.

The essence of a short is quite simple: When you short, you are selling something you don’t own. You “borrow” it (it isn’t really even borrowing), and then sell it to someone else, promising to buy it back and return it to where you borrowed it from at some point in the future. This amounts to a bet that the price will decline, so that the price at which you buy it is lower than the price at which you sold it.

Doesn’t that seem like an odd thing to be allowed to do? Normally you can’t sell something you have merely borrowed. I can’t borrow a car and then sell it; car title in fact exists precisely to prevent this from happening. If I were to borrow your coat and then sell it to a thrift store, I’d have committed larceny. It’s really quite immaterial whether I plan to buy it back afterward; in general we do not allow people to sell things that they do not own.

Now perhaps the problem is that when I borrow your coat or your car, you expect me to return that precise object—not a similar coat or a car of equivalent Blue Book value, but your coat or your car. When I borrow a share of GameStop stock, no one really cares whether it is that specific share which I return—indeed, it would be almost impossible to even know whether it was. So in that way it’s a bit like borrowing money: If I borrow $20 from you, you don’t expect me to pay back that precise $20 bill. Indeed you’d be shocked if I did, since presumably I borrowed it in order to spend it or invest it, so how would I ever get it back?

But you also don’t sell money, generally speaking. Yes, there are currency exchanges and money-market accounts; but these are rather exceptional cases. In general, money is not bought and sold the way coats or cars are.

What about consumable commodities? You probably don’t care too much about any particular banana, sandwich, or gallon of gasoline. Perhaps in some circumstances we might “loan” someone a gallon of gasoline, intending them to repay us at some later time with a different gallon of gasoline. But far more likely, I think, would be simply giving a friend a gallon of gasoline and then not expecting any particular repayment except perhaps a vague offer of providing a similar favor in the future. I have in fact heard someone say the sentence “Can I borrow your sandwich?”, but it felt very odd when I heard it. (Indeed, I responded something like, “No, you can keep it.”)

And in order to actually be shorting gasoline (which is a thing that you, too, can do, perhaps even right now, if you have a margin account on a commodities exchange), it isn’t enough to borrow a gallon with the expectation of repaying a different gallon; you must also sell that gallon you borrowed. And now it seems very odd indeed to say to a friend, “Hey, can I borrow a gallon of gasoline so that I can sell it to someone for a profit?”

The usual arguments for why shorting should be allowed are much like the arguments for exotic financial instruments in general: “Increase liquidity”, “promote efficient markets”. These arguments are so general and so ubiquitous that they essentially amount to the strongest form of laissez-faire: Whatever Wall Street bankers feel like doing is fine and good and part of what makes American capitalism great.

In fact, I was never quite clear why margin accounts are something we decided to allow; margin trading is inherently high-leverage and thus inherently high-risk. Borrowing money in order to arbitrage financial assets doesn’t just seem like a very risky thing to do, it has been one way or another implicated in virtually every financial crisis that has ever occurred. It would be an exaggeration to say that leveraged arbitrage is the one single cause of financial crises, but it would be a shockingly small exaggeration. I think it absolutely is fair to say that if leveraged arbitrage did not exist, financial crises would be far rarer and further between.

Indeed, I am increasingly dubious of the whole idea of allowing arbitrage in general. Some amount of arbitrage may be unavoidable; there may always be people people who see that prices are different for the same item in two different markets, and then exploit that difference before anyone can stop them. But this is a bit like saying that theft is probably inevitable: Yes, every human society that has had a system of property ownership (which is most of them—even communal hunter-gatherers have rules about personal property), has had some amount of theft. That doesn’t mean there is nothing we can do to reduce theft, or that we should simply allow theft wherever it occurs.

The moral argument against arbitrage is straightforward enough: You’re not doing anything. No good is produced; no service is provided. You are making money without actually contributing any real value to anyone. You just make money by having money. This is what people in the Middle Ages found suspicious about lending money at interest; but lending money actually is doing something—sometimes people need more money than they have, and lending it to them is providing a useful service for which you deserve some compensation.

A common argument economists make is that arbitrage will make prices more “efficient”, but when you ask them what they mean by “efficient”, the answer they give is that it removes arbitrage opportunities! So the good thing about arbitrage is that it stops you from doing more arbitrage?

And what if it doesn’t stop you? Many of the ways to exploit price gaps (particularly the simplest ones like “where it’s cheap, buy it; where it’s expensive, sell it”) will automatically close those gaps, but it’s not at all clear to me that all the ways to exploit price gaps will necessarily do so. And even if it’s a small minority of market manipulation strategies that exploit gaps without closing them, those are precisely the strategies that will be most profitable in the long run, because they don’t undermine their own success. Then, left to their own devices, markets will evolve to use such strategies more and more, because those are the strategies that work.

That is, in order for arbitrage to be beneficial, it must always be beneficial; there must be no way to exploit price gaps without inevitably closing those price gaps. If that is not the case, then evolutionary pressure will push more and more of the financial system toward using methods of arbitrage that don’t close gaps—or even exacerbate them. And indeed, when you look at how ludicrously volatile and crisis-prone our financial system has become, it sure looks an awful lot like an evolutionary equilibrium where harmful arbitrage strategies have evolved to dominate.

A world where arbitrage actually led to efficient pricing would be a world where the S&P 500 rises a steady 0.02% per day, each and every day. Maybe you’d see a big move when there was actually a major event, like the start of a war or the invention of a vaccine for a pandemic. You’d probably see a jump up or down of a percentage point or two with each quarterly Fed announcement. But daily moves of even five or six percentage points would be a very rare occurrence—because the real expected long-run aggregate value of the 500 largest publicly-traded corporations in America is what the S&P 500 is supposed to represent, and that is not a number that should change very much very often. The fact that I couldn’t really tell you what that number is without multi-trillion-dollar error bars is so much the worse for anyone who thinks that financial markets can somehow get it exactly right every minute of every day.

Moreover, it’s not hard to imagine how we might close price gaps without simply allowing people to exploit them. There could be a bunch of economists at the Federal Reserve whose job it is to locate markets where there are arbitrage opportunities, and then a bundle of government funds that they can allocate to buying and selling assets in order to close those price gaps. Any profits made are received by the treasury; any losses taken are borne by the treasury. The economists would get paid a comfortable salary, and perhaps get bonuses based on doing a good job in closing large or important price gaps; but there is no need to give them even a substantial fraction of the proceeds, much less all of it. This is already how our money supply is managed, and it works quite well, indeed obviously much better than an alternative with “skin in the game”: Can you imagine the dystopian nightmare we’d live in if the Chair of the Federal Reserve actually received even a 1% share of the US money supply? (Actually I think that’s basically what happened in Zimbabwe: The people who decided how much money to print got to keep a chunk of the money that was printed.)

I don’t actually think this GameStop bubble is all that important in itself. A decade from now, it may be no more memorable than Left Shark or the Macarena. But what is really striking about it is how little it differs from business-as-usual on Wall Street. The fact that a few million Redditors can gather together to buy a stock “for the lulz” or to “stick it to the Man” and thereby bring hedge funds to their knees is not such a big deal in itself, but it is symptomatic of much deeper structural flaws in our financial system.

White-collar crime dwarfs all other property crime

Aug 25 JDN 2458722

When you think of “property crime”, you probably envision pickpockets in crowded squares, muggers in dark alleys or burglars breaking into houses. But this is not the kind of property crime that does the most damage—not by a long shot.

Based on FBI estimates, the total economic value of all stolen property (in this conventional sense) is about $14 billion per year. This is less than 0.1% of US GDP.

Wage theft, in which corporations withhold pay that they are contractually obliged to pay, often by misrepresenting hours or not paying overtime rates, is by itself already $50 billion per year.

But this too pales in comparison to the real threat, which is white-collar crime. The direct cost of white-collar crime to the United States has been estimated at between $250 and $600 billion per year. This is about 1-3% of GDP; the average company loses 6% of its revenue to white-collar crime.

This is comparable to, and quite likely more than, the $280 billion total expenditure of all law enforcement and criminal justice in the United States—which has the highest total law enforcement expenditure in the world, and nearly the highest per capita as well.

This is only direct cost, mind you. If you include the indirect costs of all forms of crime, including violent crime, the total cost of all crime in the US rises to about $1.5 trillion. But this figure does not account for white-collar crime. Since the direct costs of white-collar crime are so much higher than those of other forms of crime, it’s quite likely that the indirect costs are higher as well. (Indeed, I think it can be reasonably argued that The Great Recession was an indirect cost of white-collar crime—and it cost about $14 trillion in lost economic output.)

And this is not including the approximately $300 billion per year in tax evasion (mostly in the form of unreported income and overstated charitable contributions).

The graph below compares these figures visually:

Crime pays quite well, as a matter of fact, as long as it’s the right kind of crime.

Our law enforcement system is designed to punish the crimes of the poor, and does so quite relentlessly. But it seems uninterested in punishing the crimes of the rich.

Some of the policies needed to reduce white-collar crime are quite obvious. The first is tax auditing: As the IRS budget has been cut, the number of tax audits has been plummeting, from 1.7 million in 2012 to only 1.1 million in 2017, a decrease of over a third. High-income returns—which are, obviously, where the worst tax evasion happens—have seen an even more precipitous decline in auditing. In 2011, a return over $1 million had about a 12% chance of being audited; now that probability is only 3%.

The budget cuts to the IRS make less than no sense; since 2002, they reduced spending by $14 billion and tax evasion increased by $34 billion. This is the opposite of fiscal responsibility.

Another obvious policy change is to increase spending on the FTC and SEC, the agencies responsible for investigating business transactions and rooting out securities fraud.

Meanwhile, we are actually cutting the SEC budget. This is beyond madness; the total SEC budget is a measly $1.5 billion, and collected entirely from banks, not taxpayers in general. The SEC budget does not contribute to the federal deficit in any way. And think about what madness was to begin with to allocate a budget of only $1.5 billion to regulate an industry with a market value of $26 trillion in this country alone. This is only 0.006%. Since a tax of 0.5% on stock trades, 0.1% on bond trades, and 0.005% on derivatives trades would raise a whopping $220 billion, this means that simply imposing a 0.01% tax on financial transactions would raise enough to increase the SEC budget by an order of magnitude. And this is low enough that it would be felt by basically no one. Frankly if you even care what happens to a single basis point of your rate of return, you are obviously over-leveraged. The difference between making 6.99% and 7.00% per year over 30 years is the difference between turning $1,000 into $7,590.94 and turning it into $7,612.25. That’s a difference of 2% over thirty years.

Simply increasing IRS and SEC audits would not eliminate white-collar crime, of course. It is far too ubiquitous and sophisticated for that. But the fact that we have been cutting these budgets instead of raising them speaks to a much more disturbing truth: These are not the policies of a government that is seriously trying to improve its budget balance. They are the policies of a government that is being corrupted from within, becoming tilted further and further toward the interests of the wealthy.

Financial fraud is everywhere

Jun 4, JDN 2457909
When most people think of “crime”, they probably imagine petty thieves, pickpockets, drug dealers, street thugs. In short, we think of crime as something poor people do. And certainly, that kind of crime is more visible, and typically easier to investigate and prosecute. It may be more traumatic to be victimized by it (though I’ll get back to that in a moment).

The statistics on this matter are some of the fuzziest I’ve ever come across, so estimates could be off by as much as an order of magnitude. But there is some reason to believe that, within most highly-developed countries, financial fraud may actually be more common than any other type of crime. It is definitely among the most common, and the only serious contenders for exceeding it are other forms of property crime such as petty theft and robbery.

It also appears that financial fraud is the one type of crime that isn’t falling over time. Violent crime and property crime are both at record lows; the average American’s probability of being victimized by a thief or a robber in any given year has fallen from 35% to 11% in the last 25 years. But the rate of financial fraud appears to be roughly constant, and the rate of high-tech fraud in particular is definitely rising. (This isn’t too surprising, given that the technology required is becoming cheaper and more widely available.)

In the UK, the rate of credit card fraud rose during the Great Recession, fell a little during the recovery, and has been holding steady since 2010; it is estimated that about 5% of people in the UK suffer credit card fraud in any given year.

About 1% of US car loans are estimated to contain fraudulent information (such as overestimated income or assets). As there are over $1 trillion in outstanding US car loans, that amounts to about $5 billion in fraud losses every year.

Using DOJ data, Statistic Brain found that over 12 million Americans suffer credit card fraud any given year; based on the UK data, this is probably an underestimate. They also found that higher household income had only a slight effect of increasing the probability of suffering such fraud.

The Office for Victims of Crime estimates that total US losses due to financial fraud are between $40 billion and $50 billion per year—which is to say, the GDP of Honduras or the military budget of Japan. The National Center for Victims of Crime estimated that over 10% of Americans suffer some form of financial fraud in any given year.

Why is fraud so common? Well, first of all, it’s profitable. Indeed, it appears to be the only type of crime that is. Most drug dealers live near the poverty line. Most bank robberies make off with less than $10,000.

But Bernie Madoff made over $50 billion before he was caught. Of course he was an exceptional case; the median Ponzi scheme only makes off with… $2.1 million. That’s over 200 times the median bank robbery.

Second, I think financial fraud allows the perpetrator a certain psychological distance from their victims. Just as it’s much easier to push a button telling a drone to launch a missile than to stab someone to death, it’s much easier to move some numbers between accounts than to point a gun at someone’s head and demand their wallet. Construal level theory is all about how making something seem psychologically more “distant” can change our attitudes toward it; toward things we perceive as “distant”, we think more abstractly, we accept more risks, and we are more willing to engage in violence to advance a cause. (It also makes us care less about outcomes, which may be a contributing factor in the collective apathy toward climate change.)

Perhaps related to this psychological distance, we also generally have a sense that fraud is not as bad as violent crime. Even judges and juries often act as though white-collar criminals aren’t real criminals. Often the argument seems to be that the behavior involved in committing financial fraud is not so different, after all, from the behavior of for-profit business in general; are we not all out to make an easy buck?

But no, it is not the same. (And if it were, this would be more an indictment of capitalism than it is a justification for fraud. So this sort of argument makes a lot more sense coming from socialists than it does from capitalists.)

One of the central justifications for free markets lies in the assumption that all parties involved are free, autonomous individuals acting under conditions of informed consent. Under those conditions, it is indeed hard to see why we have a right to interfere, as long as no one else is being harmed. Even if I am acting entirely out of my own self-interest, as long as I represent myself honestly, it is hard to see what I could be doing that is morally wrong. But take that away, as fraud does, and the edifice collapses; there is no such thing as a “right to be deceived”. (Indeed, it is quite common for Libertarians to say they allow any activity “except by force or fraud”, never quite seeming to realize that without the force of government we would all be surrounded by unending and unstoppable fraud.)

Indeed, I would like to present to you for consideration the possibility that large-scale financial fraud is worse than most other forms of crime, that someone like Bernie Madoff should be viewed as on a par with a rapist or a murderer. (To its credit, our justice system agrees—Madoff was given the maximum sentence of 150 years in maximum security prison.)

Suppose you were given the following terrible choice: Either you will be physically assaulted and beaten until several bones are broken and you fall unconscious—or you will lose your home and all the money you put into it. If the choice were between death and losing your home, obviously, you’d lose your home. But when it is a question of injury, that decision isn’t so obvious to me. If there is a risk of being permanently disabled in some fashion—particularly mentally disabled, as I find that especially terrifying—then perhaps I accept losing my home. But if it’s just going to hurt a lot and I’ll eventually recover, I think I prefer the beating. (Of course, if you don’t have health insurance, recovering from a concussion and several broken bones might also mean losing your home—so in that case, the dilemma is a no-brainer.) So when someone commits financial fraud on the scale of hundreds of thousands of dollars, we should consider them as having done something morally comparable to beating someone until they have broken bones.

But now let’s scale things up. What if terrorist attacks, or acts of war by a foreign power, had destroyed over one million homes, killed tens of thousands of Americans by one way or another, and cut the wealth of the median American family in half? Would we not count that as one of the greatest acts of violence in our nation’s history? Would we not feel compelled to take some overwhelming response—even be tempted toward acts of brutal vengeance? Yet that is the scale of the damage done by the Great Recession—much, if not all, preventable if our regulatory agencies had not been asleep at the wheel, lulled into a false sense of security by the unending refrain of laissez-faire. Most of the harm was done by actions that weren’t illegal, yes; but some of actually was illegal (20% of direct losses are attributable to fraud), and most of the rest should have been illegal but wasn’t. The repackaging and selling of worthless toxic assets as AAA bonds may not legally have been “fraud”, but morally I don’t see how it was different. With this in mind, the actions of our largest banks are not even comparable to murder—they are comparable to invasion or terrorism. No mere individual shooting here; this is mass murder.

I plan to make this a bit of a continuing series. I hope that by now I’ve at least convinced you that the problem of financial fraud is a large and important one; in later posts I’ll go into more detail about how it is done, who is doing it, and what perhaps can be done to stop them.