Tuesday, 9 August 2011

The Landscape of Rights - Are Rights Wrong?

The concept of rights, human or otherwise is an innately strange topic. At once uncontroversially universal-- enshrined in the universal declaration of human rights, the US bill of rights, the european convention on human rights and many more documents worldwide-- and resolutely controversial-- rights of prisoners, the second amendment etc. They are also judicially difficult, as they are almost invariably qualified. The rights of privacy and free speech were almost made to exist as two great deities of the law locked in eternal combat.

And there is some dispute as to where they come from. Are they ‘self evident’ to borrow a term from the declaration of independence? Are they forged from moral philosophy, or from self interest? Certainly history provides some useful context here. Moving backwards from the Human Rights Act 1998 with its ECHR protections against torture, of life and of freedom of association and privacy, the US bill of rights contains slightly more practical components concerning billeting of troops and maintaining militia, and the English bill of rights 1689 and the Act of Settlement 1701 together provide an essentially political and constitutional settlement, setting out powers and restrictions, particularly concerning the independence of the courts.

The concept of a right as we imagine it today is evidently an umbrella term. This stems in part from the linguistic character of a statement of right as recognised in Hart’s theory of law. A word may have a ‘core’ meaning, and a penumbra of less clear possible meanings. The right to life clearly means the right not to be murdered, but what about turning off life support to a brain dead person? What about an embryo early in its development? Even this relatively clear-cut concept has its areas of dispute.

Even with the simple protection from killing we run into some difficulty. We have the right not to be killed, but can the state execute us? Can a right ‘protect’ us from murder, or merely punish those who murder us? Do we have a right not to be struck by lightning? Do we have a right to the best medical treatment possible, no matter how expensive, if there is some chance it will preserve our life?

This difficulty stems from the word itself. A right is an entitlement or a protection. It is a claim to some benefit under law. You may have rights arising from a contract, or rights which are constitutionally granted. You may even have rights which arise from custom or ordinary and expected behaviour. This suggestion of entitlement provokes a cultural effect, and it affects how the population understands the meaning and role of ‘rights’ within society.


There is of course another framework for investigating rights: that of duties. It has often been suggested that each right has a corollary duty which it imposes upon society, and we may understand each right as in fact resolving a cluster of duties within society. The right to life may invoke the duty of the state to always punish murderers-- and those who through negligence cause death. It may involve a duty to ensure that workplaces are sufficiently safe, or that healthcare is provided to all. In some jurisdictions it may incorporate a positive duty of citizens to intervene to save those in peril, or it may, as in english law, refuse to punish a citizen who, seeing a drowning man, simply keeps walking.

It cannot be without limit, the state may resolve that it has a duty to provide all citizens with necessary and sufficient care, but not with all possible care. The NICE group in the UK evaluates the months of life and quality of life saved by each treatment, relative to its cost, and they do this so as to achieve the greatest good possible for a given budget. In all healthcare systems near limitless demands are placed on finite resources, and healthcare decisions may be made by markets-- where those with the greatest wealth secure the best treatment-- or on a cost-benefit analysis as conducted by groups such as NICE.

The state may assert that women have a duty not to abort embryos after they have reached a certain point in their development, but equally they may not assert any such duty prior to that time under law, thus permitting the negative liberty to have an abortion. They may also mandate a duty for the healthcare system to assist any mother who makes such a decision. No duty can arise which defends the citizen against a lightning strike, but a duty may exist for the police to do all they can to prevent a murder, as was seen in the yorkshire ripper cases.

The Rights of Murderers

In light of the necessary complexity of even simple rights challenging social problems can ensue. One prominent example is that of victims rights vs the rights of the accused. As in the adversarial system of justice practiced in the west the family of a victim may be aggressive cross examined there is a legitimate outcry among many in the public that the rights of victims are sacrificed in favour of the rights of the guilty. The primary duty of the justice system however, is to cause no injustice by its action. The example earlier this year of the landlord of a murder victim whose name and reputation was destroyed in the press before turning out to be completely innocent is a good example and an important warning.

This balancing act between our collective duty to ensure fair trials and protection to the falsely accused, and our need to prevent further suffering to victims is a frustrating and agonising one. Although it often comes up in murder trials it is far more routine in rape trials, where the only evidence may be the testimony of the victim, who is inevitably forced to relive the ordeal and face their attackers.

These are difficult situations. The law of evidence is complex, and even it has roundly failed to keep up with research into the reliability of witness and memory evidence. It is impossible to expect the ordinary person to appreciate the role of the judge in deciding which lines of questioning are acceptable or even necessary. As a result we get involved, not in procedural questions about the law of evidence, but in debates about who has more rights, criminals or victims.

For this reason the language of duties has a tremendous benefit to offer us. Our rights can only survive while others in society maintain their duty to respect our rights. Emphasising our duty to our common man is vital if we are not to lose sight of the source of our own rights. Assuming rights as static and inherent allows us to make claims without considering the costs.

Self-Evident Rights

Nonetheless rights do have a defence and a justification. They are and will always be an important concept and tool. We may speak of the duty of a foreign government not to oppress its people, but the phase human rights reminds us of our own rights, and encourages us to imagine ourselves in the situation of those who do not enjoy them.

Rights themselves are effectively bundles of social practices and customs developed over millennia, some of which are necessary for a society’s survival, and some of which are even evolved. The logic of evolution tells us that a creature which is incapable of surviving to breeding age will not pass on its genes. A similar logic informs us that a society whose rules must inexorably lead to its destruction will not survive to pass on its rules and customs.

In this sense there is something intrinsic and objective to many rights. Our abhorrence of murder is absolutely necessary to a functioning society. Otherwise we would live in a society of sociopaths, where killing was justified if it provided a benefit to you.

Even so, this idea of rights as objective or natural can only take us so far. We may not sanction murder but we do still undertake actions in the name of self interest which are ultimately self destructive. The tragedy of the commons describes a community who, having no rules between them, collectively over-graze, each trying to get the most for themselves, until the land is destroyed and their livestock die. This exact tragedy has happened on a small scale a number of times in world history, but to most readers the immediate parallel will be that of global fishing policy, which year on year sees devastating and potentially irreversible declines in total stocks.

Climate change, grazing and fishing, the treatment of arable land. These are all obvious examples, and they show us that rights generally exist within a society, and do not extend to those outside of it. We would even say there is a duty on our government to achieve the best deal in the interests of our nation in any given situation-- to act in a self interested way. Clearly, as in the two bills of rights mentioned earlier, rights are often political compromises arrived at by parties to a negotiation, whether their power derives from a democratic mandate, financial clout or military capabilities.

For this reason many rights, once enshrined in law, become artifacts of a historical reality long since evaporated. The US constitution has been amended many times since its inception, and while many elements of the english bill of rights remain central to british politics, the act itself reflects a preoccupation with catholics and protestants which clearly is not germane to current policy.

In fact rights which become part of the structure of a society in this way may not survive at all in their original form. The bundle of duties and obligations associated with them may change markedly. The general ‘concept’ of any given right will morph and shift as public attitudes and understandings do. This provides a certain flexibility, though, as perhaps seen in Roe v Wade, there are limits to how far a right can be credibly expanded by creative interpretation.

Interpretation is a key word. The ‘general concept’ of a right allows the courts to map out that larger bundle of duties, deciding whether a local government decision to take aware social housing could have violated a ‘right to family life’, or whether a doctor should or should not be allowed to separate conjoined twins, if it means that one will die, but if doing nothing would lead both to die. This space allows judges room in which to circumscribe the geography of social expectations and norms.

The flip-side of this is that we must be wary of ambiguity. The American Second Amendment has led to a centuries old dispute over gun rights that may never be resolved. These difficulties can divide society without providing any clear benefit whatsoever, and it is important that rules such as these can be cleared up, changed or removed as required by the times.

The Landscape of Rights

Rights once adopted can become central to how a society operates. Property rights and rights under contract are central to a capitalist system. A right to housing or to health might be characteristic of a welfare state. Yet rights are not necessarily moral norms. Property rights might appear to be moral norms to some in a society, but if a particular section is sufficiently disenfranchised, they may come to view these rights as carrying little moral force. To take the jean valjean example, your property rights carry little moral force if I need to steal to feed my family.

So rights not only involve changing configurations of duties, but the way they are perceived and the moral force they carry can change as well. The right to property may exclude income taxes, and the degree to which those taxes are progressive in a society will affect the attitudes of citizens.

The landscape of rights in societies will therefore be very different, even if they have those same core rights: The right to life, right not to be tortured, a right to privacy, and so on. And rights cannot operate successfully if they do not achieve legitimacy, as they cannot survive if the duties which underpin them are not taken seriously by the majority of the populace. It may be reasonable to assume that this will affect the character of communities in those cultures.

Wednesday, 3 August 2011

Essay on the Financial Crisis - Notes for the Uninitiated

 Safe as Houses

I originally wrote a version of this article some four years ago. It was not easy then, it does not come easily now. Economics is a field of manifest complexity, where each element affects and is affected by the operation of all others. Fortunately it is human nature to cleave to narrative, and so disect the still frame from the tumult of activity, so I have chosen to treat this as a journey, and the journey begins at home.

A house is an unusual thing. It’s a necessity, a luxury and an investment all rolled into one. They cost time and money to upkeep and evoke feelings ranging from comfort and security to shame and anxiety. Making the mortgage payments is a fact of modern life, and the primary reason that ordinary people care about the rate of interest.

Normally when the price of a good changes we adjust our priorities as well, via a concept known as ‘opportunity cost’. We determine the value of any given thing by comparing it to what we have to give up in order to have it. Do we work an extra hour and earn more money, or have an extra hour of free time? Do we buy a soft drink for £1 or two mars bars for the same price? Naturally if the price of one thing changes, our decisions about what to do may change as well.

Normally this functions as a negative feedback: if prices go up we buy less, and if prices go down we buy more. So far so reasonable. Returning to the subject of houses however, it is clear that this does not necessarily hold true. If house prices in general are going up we may want to buy one more than ever, and be less inclined to sell. This is because of the ‘exposure cost’ faced: If prices are going down you may want to sell as quickly as possible to avoid having to sell for less in the future, whereas if they are going up you might want to hold out for more money.

This produces a positive feedback, a self-catalysing effect on prices. This is normal in supply and demand relationships, but the positive feedback rarely overcomes the negative feedback detailed earlier, which we shall call the ‘affordability constraint’. Houses unlike mars bars can be mortgaged however, allowing for ‘securitised loans’; loans which are seen as safe because they can be paid via the sale of the house if necessary.

Banks will always set a specific Loan to Value(LTV) ratio, this is the percentage of the price of the house that they will lend to you, the remainder being the deposit and any associated fees and transaction costs. This ensures that even if they have to sell below the market price they can still get their money back. When house prices are increasing significantly however, and are expected to continue to, banks will respond by increasing the Loan to Value ratios they allow.

This is because if a house is worth £100,000 this year, but it is expected to be worth £110,000 next year, a mortgage of £80,000 at 80% LTV given out this year will become 73% LTV next year. As a result, they can allow an LTV of say 90%, and still expect it to approach 80% as prices go up. And this lets them give larger mortgages to more people, which in turn means more interest payments and larger market share in the banking industry. So if one bank doesn’t do it, other banks will outcompete it. This engenders a sort of inevitability as you can imagine. The selective, darwinian pressures of the market ensure an expansion of risk.

Now if LTV ratios are going up and interest rates remain constant, the affordability constraint will be weak. It will be easier for people to get mortgages, and therefore to buy houses and this means more people will do so, hoping to profit from the increases in price. And as more people buy houses the price of houses will rise.

The Miraculous Economy

During the height of the boom credit was easy, due in no small part to the boom in housing. Credit card debt could now be added to the mortgage in the form of 'debt consolidation'. Because mortgages are secured against the value of your house they always have lower interest rates than unsecuritised loans, such as bank loans, overdrafts and credit cards. These unsecured loans represent greater risks to the lender and so they demand a higher yield in return. Consequently many people were encouraged to remortgage, increasing the value of their mortgage so as to pay off other, unsecured loans. Financial advisors received procuration fees for every new mortgage, incentivising them to encourage private individuals to take this course of action, and as it saved them money on interest it was easy to justify.

With debt so easily transferred the default rate reached a record low. Why would you default on your credit card debt if you can put it on your mortgage at a lower interest rate, after all? And these low default rates gave the illusion that credit was low risk, encouraging lenders to give out more and more. This meant more people had access to cheap credit, and allowed for greater spending by otherwise cash-strapped households.

The extra spending supported increased demand in the economy and with households buying more of everything, corporations borrowed increasing amounts in order to expand and build more stores, hire more people, and inevitably to pay their executives more. In the general expansionary environment corporate shareholders enjoyed a rise in the value of the companies they had invested in, as the environment of increased demand provided companies a relatively safe and stable future and potentially a very profitable one.

As corporate share values go up the dividend gained per unit cost of a share declines; the higher the price the less their value as an investment. The same is broadly true of all investments and high priced bonds give poor yields. As supply and demand dictates, the more demand there is for investments the higher the prices, and there was a lot of money at the height of the boom. Large amounts of it came from overseas, but interest rates were low and credit was overflowing. This meant declining yields, and in order to earn greater yields greater risks had to be taken, and at precisely the same time the opacity of many derivatives was only increasing.

The financial sector started tranching off mortgage debt based on patterns of risk into packages of debt, graded and in theory valued. In reality although the market price of these was based on the underlying value of the original asset, their actual worth on a company’s books depended on market buoyancy, and liquidity. Liquidity is the measure of how easily something can be converted into cash, or, in effect, sold. A house is fairly illiquid; it takes a while to sell one as many people know to their cost. A derivative based on debt on the other hand is fairly easy to sell, or was.

The Other Side

Now all good things must come to an end, and sooner or later you hit a ceiling where the negative feedbacks overcome the positive feedbacks. That is, affordability is impossible no matter what incentives and facilities exist to support it. Despite some loans having a loan to value of more than 100% there had to be an upper limit. Eventually house sales declined, and this tipping point reversed the momentum of the market. The positive feedback now trended downwards.

As house prices decline remortgaging becomes nearly impossible for many people, loan to value ratios which were on the generous side before suddenly become miserly as banks grow desperate to keep some leeway between them and falling prices. Without the ability to remortgage credit card debt becomes the only way of accessing money for those on the edge, but with no way of lowering its rate of interest on unsecured debt they are unlikely to be able to repay. Risk has returned.

Without access to cheap money spending by the public must decline. With less spent on private sector goods and services there is a fall in jobs and wages as companies adjust to the new reality. The growing ranks of the unemployed find it increasingly difficult to avoid default, and this adds to the pressure on lending, and on houses which are sold at below market rates by desperate banks.

Of course these loans are the underlying value for many derivatives, and uncertainty about defaults sends shockwaves through the markets. Investors suddenly unsure as to which debts are toxic, and the more uncertainty grows the harder it is to sell 'dodgy derivatives'. The more they are sold to unwilling buyers the lower the market price, but for those who hold on to them there’s no guarantee of getting the money back because of defaults.

As derivatives turn toxic banks become skeptical about the holdings of other banks, and become less willing to lend to them, and this further increases the magnitude of the crisis-- many financial institutions are unable to secure loans themselves now. Those highly indebted financial organisations which took out short term loans to fund long term investments find it incredibly difficult to find the funding they need just to survive. In real life, this was the fate of Lehmans.

With loans to firms becoming dangerous in this atmosphere of reduced aggregate demand fewer loans are given out, and higher interest rates are charged. Firms are unwilling to invest if they think future demand will be low, and if the cost of investing (the interest rate) is too high. Consequently, investment will be low for a long time after such a crisis.

This scenario with both its ups and downs is a leveraging-deleveraging cycle, and it forms a so-called ‘S’ wave. The positive feedback accelerates the direction of change, first up, then down, and the down part is what we know as the crash.

Experiments in inequality

There are a number of reasons this unfolds the way it does. One is simply capital gains. A capital gain is the profit secured by holding onto something as it increases in price. This includes owning a house while house prices rise, but it also includes starting a company which increases in value over time. Long term capital gains are generally good, as they represent a return on a serious investment in something. In the short term they can be good, as with arbitrage. The danger is speculation, short term bets on price movements which themselves exert the force that only the movement of money can.

The capacity to make money off the shifting values of goods whose value is determined by demand can at times be, of course, dangerous and of dubious value to the economy. The same can be said of the opacity and complexity of some financial products and transactions. Clearly these are all things which can be looked at in different ways.

Another, more interesting factor is inequality, which is at times almost the elephant in the room in these discussions. The role of inequality in these crises is causally complex but incredibly important. Economies function as a whole, companies which make billions from sales only do so because there are millions of people who are not wealthy buying their goods and services. Inequality tends to naturally increase in a capitalist system over time and this can create problems.

To illustrate this it’s best to start elsewhere with the concepts of 'hysteresis' and path dependency. Take a hypothetical example which matches many real life situations: That of a relatively isolated village. If in this village noone has much money, they can’t spend much, this means few companies will be attracted to set up shop there to sell them things, which means fewer local jobs, which means less income. This vicious circle might lead to the youth leaving for more affluent areas in real life, and to a rise in the invisible and underground economies as the residents seek to satisfy the demands they cannot express in the monetised economy.

The point is the catalytic effect; the expression of demand is path-dependent. This truth emerges in strange and familiar places: people who grew up drinking coca cola may tend to buy it in the future, even if there is an objectively better drink available. Indeed, some studies have shown that via a variant of the placebo effect we enjoy brand name drinks more than otherwise identical non-brand products simply because of brand awareness. We rely on our subjective valuations enormously. If we believe something tastes better, feels better, makes us feel better, then to us it is better, and that's worth money.

So market dynamics are not purely fluid, they can exacerbate existing trends and form structures and landscapes. Some geographical regions may have infrastructural advantages developed over time that others lack, but so do many some societies and cultures. A culture which adopts a mode of cooperative behaviour may develop an advantage in training new workers, or in developing new research. Historical examples include the Royal Society of the 17th century in England, and Silicon Valley in the US.

And this is also true of different wealth levels, where the wealthy are able to live near the best schools and in the safest neighbourhoods by bidding the most for houses in those places. This self-segregation grants an immediate advantage to their children even if they attend a state-run school as their children mix with the children of other affluent families and develop confidence and connections. These internal structures within an economy are critically important to understand and must not be underestimated.

Two Halves Drifting

If inequality increases over time, then the ‘bottom’ and the ‘top’ of the economy are effectively becoming distended away from one another, even if overall wealth is increasing over time. Yet those at the bottom need to keep spending in order to keep economic activity going, despite lower job security during recessions. This is where so-called automatic stabilisers--such as unemployment benefits-- enter the picture. These are policies which act to prevent temporary unemployment from dramatically decreasing demand in the economy, or decreasing the human capital of the unemployed. These lead to greater government spending in recession, and lower in booms, at precisely the same time tax takes are correspondingly shrinking and expanding respectively.

If inequality continues to grow unabated there are two possible paths. Either wages keep pace with costs of living, or, if this does not happen, those on the margin will begin to supplement their income with credit. This is not irrational. We may expect a pay increase in the future, or believe we can work extra hours if we need to. We may even hope to find a better job. In any case, it can be assumed that there is a certain standard of living below which any given individual will not allow themselves to fall if credit is available. And this level will vary in each society, and even from one family to another.

As sections of society slip into debt they have to pay interest, which only adds to their costs and almost invariably leads to more debt, and more interest. This may not seem at least to be inevitable but it is extremely probable. The reason for this is to be found in psychology.

Even ignoring the swelling ranks of the homeless in extremely wealthy countries like the USA, or the many millions on food stamps, there is still a serious poverty problem in the west. This poverty is relative, it derives from the psychological effects of not keeping pace with the society around you-- of feeling poor compared to your expectations. Studies have indicated that even the relatively wealthy may feel impoverished-- though they attract little sympathy-- if there are those around them who are wealthier still. Contained in all this discontent are the incentives and pressures which drive low income families to live beyond their means despite being relatively better off than their ancestors. In a capitalist society there is an ever-extending continuum of wealth before you, and the exultation of wealth in the west is partly to blame for the dysfunction this has bred. Not all of this is purely status related either, the internet is a recent advance, as are mobile phones, but both are necessary to participate in job-seeking, the knowledge economy, etc.

Those who are poorer enjoy, on average, worse prospects and a lower probability of increasing their prospects over their lifetime and the data shows this. They have less security, in terms of either job security or assets to secure loans against. As a result they pay higher rates of interest because they are regarded as a greater risk to lend to. They will usually end up paying 200-300% of the value of a mortgage over its lifetime, and stand to pay even more on unsecured debt such as credit cards. On the other hand, those who are wealthier will enjoy lower interest rates and ready access to money, or they may simply lend the money they already have out and generate returns.

As for wages, with increasing global demand and diminished resources, energy and food prices cannot help but rise in the world marketplace. As the wealthy buy up housing in good areas, and perhaps second homes, or even buy houses and flats to rent out, this spillover of their superior relative resources bids up the price of housing, making it less available in the regions where most of the jobs are. The poor also have higher information costs-- they have less time and less developed skills for finding the cheapest deals, understanding how tariffs work, etc. Indeed, many companies give better deals to those who change companies (for introductory discounts) than to existing customers. As a result, there is a tax on those who do are not aware of the way things are sold.

 If wages are not keeping pace with the cost of living it is nearly inevitable that the top and bottom of the economy will stretch further and further apart until something snaps. And that too is an illustration of the financial crisis. Just prior to 2007 newspapers and magazines were noting a "new gilded age", where 90% of the wealth in society was owned by the top few percent. Three years later US U6 unemployment indicated that 17% or so of the labour force was either unemployed or underemployed, and overall participation in the labour force had dropped.

If the poor enjoy diminishing resources, capacity to engage with broader society, and can hand down only bleak expectations to their children, it is not only they who suffer. The markets may quite naturally allocate a higher risk and worsened opportunities to the less well off, but there is nothing in nature that so specifies their potential. They could be so much more, for themselves, and for the society-- and economy-- as a whole, if they had better hopes. The crisis could only happen once demand collapsed; when the poor collapsed. It represents the culmination of a collapse of the relationships within society, and in the long term it threatens to damage our productive potential as a people. That is the true role of inequality in all this, both cause and consequence, and the most serious thing that is not being discussed at the moment.

The Rational Spirits

The work of recovery is not just to ‘make the banks safe’, it is also to redress declining social mobility, to rebalance the economy as a whole, and to change the way the financial system distributes rewards and costs. Keynes’s ‘animal spirits’ are not irrational, but complex systems mean that the results of a given micro behaviour can change with aggregation and operate differently at different scales. This is true of any of the physical sciences and it is true of economics as well.

It is the rationality of the actions which make them so dangerous. It is rational to lend more if everyone else is and prices are going up, or else you’ll lose market share. It is rational to hold out for a better price on your house. As John Kay once noted it is even rational for a company to fire someone who won’t take actions that will make the bank competitive-- even if in the long run the consequence is disaster.

Rationality is contextual, it is bounded, to use the correct term. Which is to say, the rational course of action changes based on our situation and how much we know and understand about the consequences of our actions, there is no straightforward dichotomy between rational and irrational. This is doubly so at a collective level. An obviously rational individual decision, such as to save more, can become disasterous if everyone does it at once, as Keynes most famously observed in his paradox of thrift. To understand the crisis we must understand markets as emergent systems derived from our contextual behaviour, and aggregated into systems whose parameters of action are far beyond their basis in homo economicus.

We must remember that markets are not entirely natural-- they are adopted mechanisms we use for a very good reason: they achieve excellent results in many areas. Nor are they perfect. They cannot be the answer to every question, not least when many of us are asking different questions and seeking different outcomes. But if we are to employ them in a given area, we must first understand them and how they work, or we will almost certainly live to face the unexpected consequences.