Building reliable systems out of unreliable parts

The following rant was inspired by listening Econ Talk Garett Jones on Fisher, Debt, and Deflation while running.

There's a certain type of fundamentalism around the belief that government is necessarily dysfunctional. Reasoning that government is likely to spend and regulate unwisely, adherents advocate spending cuts and limitations on regulatory authority. The failures of defunded and hamstrung agencies then serve as further proof that the public sector can do little right. If further proof is needed, it's easy to find examples of state sponsored screw-ups.

These same individuals are often more credulous about the competence and probity of corporations. This faith seems undiminished by mountains of evidence in the events of recent years that it is misplaced. Businesses leveraged themselves to the hilt, made and traded risky loans with abandon, and felt almost obliged to keep dancing while the music kept playing.

It should be clear to all that an economic crisis of the magnitude of the great recession that began in 2008 couldn't have happened without substantial errors in both public policy and business decision making. Such as:

• too much leverage
• complexity and absence of regulation of derivatives
• lax regulation of the traditional parts of the financial sector
• perverse short-term incentives, moral hazard and lack of accountability on the part of the financial sector, especially investment banks
• moral hazard and lack of accountability in government sponsored entities like Fanny Mae.
• outright corruption (for example in loan origination) and regulatory agency shopping
• policy encouraging home-ownership for high credit risk buyers.

Economists debate the degree to which stickiness of prices and wages magnify short-term blow-ups. One extra difficulty of a real-estate driven recession is that long-term contracts like mortgages are about as sticky as it gets.

Economic adjustment happens at different rates - from the millisecond response times of high-velocity algorithmic traders to the months it takes to sell a house or mop up after a bankruptcy. These mismatched rates present opportunities for arbitrage, but if they become severe enough, they can break established systems. Examples include collapses in overnight interbank lending during recent crises and the flash-crash of May of 2010.

Corporations are powerful engines of wealth creation. Countries without governments are not nice places. Both are flawed, but we'll have to stick with them, at least until we find better alternatives.

But, organizations built of humans are bound to be flawed, because they're built of flawed parts. History can be viewed as a series of attempts at engineering reliable systems from unreliable parts, with varying levels of success.

The political and economic dimensions of organizations, public or private, are inextricable. The rats are always trying to find a way in.

Matthias Seifarth