Notes from John Staddon’s ‘The Malign Hand of the Markets’

Staddon, J. (2012). The Malign Hand of the Markets: The Insidious Forces on Wall Street That Are Destroying Financial Markets–and What We Can Do About It. McGraw Hill Professional.

Preface

Introduction

1. The malign hand appears wherever benefits are immediate and discrete for an individual/a group, while costs are delayed and/or dispersed for others (p. xxi)
2. Reinforcement contingencies are simply the rules by which rewards and punishments are given or withheld (p. xxii)
3. Seeing financial instruments as reinforcement contingencies shifts the analyses of economic behavior from the rational-irrational dichotomy to one of adaptation (p. xxvi)

Part I

Chapter 1 – The Malign Hand

1. Bureaucracies increase because the incentives of bureaucrats do not align with the incentives of the organization they are a part of (p. 4)
2. Competition is the natural antidote to the malign hand (p. 4)
3. Politicians divert national funds to their districts. This leads to immediate concentration of benefits to the members of the district and a delayed dispersion of costs to the larger nation as a whole. Of course, those who bear the cost have less influence than those who incur it (p. 6)
4. There is a tradeoff between efficiency and stability which is not too removed from the tradeoff between immediate gains and delayed benefits. As global systems become more interconnected, they will become more efficient in the short-run at the risk of instability to the system in the long-run (p. 11)
5. Organisms prefer positive reinforcement to negative reinforcement (p. 15)

Chapter 2 – Democracy, Fairness and the Tytler Dilemma

1. Alexander Tytler, a 18th-century Scot aristocrat, is attributed to saying have said that: “A democracy cannot exist as a permanent form of government. It can only exist until the majority discovers it can vote itself largess out of the public treasury. After that, the majority always votes for the candidate promising the most benefits with the result the democracy collapses because of the loose fiscal policy ensuing, always to be followed by a dictatorship, then a monarchy.” Staddon interprets that private good as immediate benefit from public treasury, and collective bad as public bankruptcy (p. 23)
2. Problems arise when benefits received by an individual/a group is not linked to the behavior of that individual/group and is paid by other (p. 26)

Chapter 3 – Value and Reason

1. Defining value in objective terms is referred to as the naturalistic fallacy (p. 40)
2. Adam Smith defined value as the work done to acquire a commodity. This is also referred to as the labor theory of value. However, oxygen is freely available to everyone and doesn’t demand much effort, while gold is scare and requires much effort to attain. Yet, one will not conclude that gold is more valuable than oxygen. Some economists then made the distinction between value in exchange (gold) and value in use (oxygen). Another way to see Adam Smith’s definition of value is to lay more emphasis on the willingness to work (a property of the decision maker), as well as the commodity’s reinforcement schedule, as opposed to the real work done to obtain the commodity. In all, value is not a property of the commodity itself. Thus, to make an assessment of relative value, both the effort, as well as the reinforcement schedule must be considered. When reinforcement schedules are similar, oxygen will be more valuable than gold (p. 41)
3. A decision maker has a set of different strategies (variation) and some means of comparing them (selection). If the strategy set is rich and the selection rule appropriate, the resultant behavior will be apparently ‘rational’. However, if the strategy set is limited, or the selection rule inappropriate, the behavior will appear to be biased, or based on a heuristic (p. 48)
4. There nothing like purely rational behavior. If the task is simple and close to something encountered in one’s history, behavior will come close to a rational optimum. However, when the situation is complex, subjects will act irrationally, or rational in the short-run (p. 49)
5. Behavior can be rendered rational once the currency and the constraints are salient (p. 49)
6. Maladaptive behavior is a consequence of recent history and feedback effect of present behavior on the future. Staddon calls this ‘leverage’ (p. 53)
7. There is no single rational strategy, multiple ones depending on the what is maximized and the constraints (p. 54)

Chapter 4 – Efficiency and Unpredictability

1. In everywhere, except economics, efficiency is usually a ratio. In economics, it is defined in as the extent to which commodities’ prices are reflective of information (p. 55)

Chapter 5 – The Housing Bubble

1. Frank Knight (1921) distinguished between risk, where the odds can be calculated; and, uncertainty, where the odds cannot be calculated (p. 79)
2. The future is like the past over a short period. The present will at some point fail to match with the past – but we don’t know when that will occur (p. 80)

Chapter 6 – Market Instability and the Myth of Comparative Statics

1. Greed is a constant of human nature and as a result, market bubbles cannot be solely explained by them. What is more likely is a malign schedule of reinforcement. For many brokers, individual upside outweighs personal downside. But for the financial system as a whole, the situation is reversed. Similarly, brokers have leverage because they control large amounts of money while only responsible for a fraction of it (p. 95)

Chapter 7 – Growth and the Conservation of Money

1. Instead of looking for the causes of boom and busts, it might be better to explore the kinds of constraints that can stabilize markets (p. 101)
2. Hobbes and Rousseau’s conceptualization of man ignored the role of markets and the need to for individuals to trade (p. 107)
3. Staddon is suspicious of any measure of economic growth reliant on money. The Incas and Aztecs probably had a higher GDP than their conquerors. Yet, their wealth made them more of an easy target. Rather, growth can be better assessed with freedom (people aren’t spending all their time looking for food or housing) and resilience (people can better adapt to change) (p. 107-8)

Chapter 8 – Debt, Inflation and the Central Bank

1. Inflation functions like a flat tax on both wealth and income. Thus, even when people get salary raises, their wealth remains constant. (p. 121-2)
2. Constantly falling price are not hazardous to the economy. The price of clothes and electronic products have declined over the years, yet their markets have not stagnated (p. 127)
3. Deflation is only bad for debtors since as time passes, the worth of their debts will increase. On the other hand, inflation hurts people who save money (p. 128).
4. The Central Bank (Feds in the US) controls interest rates by buying up short-term treasury bills. Since the Feds use cash reserves to do this, banks have more money to lend at a low interest rates. As with the law of demand and supply, the increase in supply of loans drives its price (interest rates) low (p.134).
5. Quantitative easing occurs when interest rates are close to zero and the economy is still in a recession. Rather than only buying short-term treasury bills, the government buys other types of securities, e.g., corporate bonds, etc. The money to do this doesn’t come from the reserves, but is simply created by the Central Bank (p. 135)
6. When the Central Bank buys short-term treasury bills, it is usually a sign that business will be bad in the future (p. 137)
7. The more complex a security or asset is, or the greater the uncertainty about its value, the more its price will be determined by other people’s behavior (p. 139)
8. Two cause of bubbles – herding and a new money supply. Again, since herding is human nature, the problem may be better solved by looking at the way governments supply money (p. 140)

Chapter 9 – J M Keynes and the Macroeconomy

1. Adaptation is the result of variation, which is endogenous; and, selection, which is determined by the environment (p. 151)
2. Neither the pattern of incentives, nor the market sentiment on its own can explain economic behavior – we need to understand what people are willing to try, what informs/motivates this willingness, and the consequences of people’s actions (p. 153)
3. The problem for the political system is how to restore confidence in the economy while harming as few innocent victims as possible, while punishing those responsible for causing economic slumps (p. 158)
4. If the economy is like a leaky bucket, the solution is to either reduce the leak (structural changes) or permanently increase inflow (inflation) (p. 160)

Part II

Chapter 10 – Financial Markets are Different, I: Problems and Some Solutions

1. Information has to be converted to action. Saying, like the Efficient Market Hypothesis, that stock price reflects all information about the underlying stock is borderline religious (p. 180)
2. Complexity of financial markets should be subject to some check, such as tests for comprehensibility (p. 186)
3. Technology in agriculture reduced agricultural employment since farmers became more efficient. The same cannot be said about financial markets where technology is used in complexifying (p. 192)

Chapter 11 – Financial Markets are Different, II: Risk and Competition

1. In a competitive market, injury to one firm will make others more profitable (p. 202)
2. Bloated profits of the financial industry come from the future. A few people’s current payouts will be suffered as debt in the future – in the form of debt defaults, higher taxes or inflation (p. 206)

Chapter 12 – Financial Markets are Different, III: Regulation by Rule

1. There should be a tax on financial risks – negligible tax on small risk and large taxes on large risks (p. 232)