"The short answer is their business model does not depend upon a belief system — of solvency, liquidity, profitability or risk management."

Steve Hsu on Information Processing with an interesting post:

"Which raises the question: Why [no] runs on semis or software companies? The short answer is their business model does not depend upon a belief system — of solvency, liquidity, profitability or risk management.

It wasn’t a crisis of confidence that did the iBanks in, it was a crisis of competence.

That was the element CEOs like Dick Fuld, Hank Paulson, Stan O’Neal and Jimmy Cayne failed to consider: When you are a bank, your existence depends upon the confidence of your clients, investors and counter-parties. Anything you do that puts that at risk is extremely dangerous. If you want to run lots of leverage, push the envelope, well, then, you better hope nothing else goes wrong. At 35X, you do not leave any room for error.

It is inexcusable that the investment CEOs did not seem to realize this. It was unconsionable that the firms had been purposefully put into a risk taking position in extremis. That the CEOs blamed short sellers and rumors, but exonerated themselves, only serves to emphasize their own failures, their lack of comprehension of what they had dome to themselves. It was their own incompetent stewardship that purposefully and unknowingly placed these firms at such grave danger of destruction.

Macro modelers take note: no realistic results without accounting for ape psychology. "

This is an important point. I interpret it in the following way:

If the banking system is perceived as unsound, then it is in big trouble, whatever the real situation is. However, I believe that the banks did not believe that the government would let the banking system be perceived as unsound. They believed that any bank large enough to signal such a situation would be saved. They were correct, but the effect of not saving Lehman was to raise doubt about that belief. Once that step had been taken, there was a rush by people to cover their positions in case the government was going to actually let the system take big hits.

This is one reason that there was no option to the government intervening. The idea that the large unsound banks should be left to fail, and that would have no effect on confidence in the banking system in general, just doesn't make sense to me. In this situation, there was no practical choice but intervention. What I fault the Fed and Treasury Department for is not confronting this situation head on and adopting a series of policies that haven't been able to stop the fear and aversion to risk precipitated by this crisis. Sadly, some of their actions, by seeming so panicked and seat of the pants, might well have made the crisis worse.

When you confront a Belief System, you must know the underlying context, presuppositions, and beliefs, that are underlying it. A competent and effective response can't come without that knowledge.

"Knight argued that making such decisions was the job of an entrepreneur"

One thing to like about Justin Fox is that he tackles big ideas. Here he takes on Uncertainty:

"The future seems especially uncertain at the moment. There are those who would object that the future is always uncertain, and that it is when we think we've captured it in our forecasting models that we've invariably gotten things terribly wrong. But still, it is possible most of the time to be reasonably confident that one knows the range within which growth, inflation, and other important economic variables will fall for at least the next year or two. It's that confidence that allows business executives and investors and consumers to make decisions."

First of all, he links to Taleb who I basically agree with, and I take it that he doesn't. But that's fine. Thinking that you're reasonably confident about the future can get you in trouble, but so can being terrified of it.

"Right now that kind of confidence is in extremely short supply. The economy is shrinking at a rapid pace. That won't go on forever, but when it will end, and what the recovery will look like, is anybody's guess. Are we about to get sucked down into a deflationary spiral, or are the Fed's aggressive actions eventually going to make inflation the real threat? Is the global economic clout of the U.S. going to be permanently diminished by the current crisis, or does this represent a second chance to get things right? Are we really about to enter a new age of thrift, or just take a time out before returning to borrowing and spending? Are we looking at a long-term malaise, or a sharp-but-short shock?"

See, there's a difference between uncertainty and fear and aversion to risk. One way to read the current market, for example, is that people know that deflation and bad times are ahead, and they're investing accordingly. It's not uncertainty that's causing panic, but rather the certainty of bad times ahead. By the way, some people do better in a downturn, just as some people will do better in deflation. I don't see that confidence distinguishes among particular choices at all, as to where the economy is going. I think that real investing means trying to overcome both confidence and fear, at least as best a human being can, and make competent decisions based on what you then see. It won't be perfect, but it's the best you can do. Attributing an advancing economy and business growth to confidence doesn't describe the complexity of human decision making and behavior.

"When one is not confident about the answers to such questions, the natural tendency is to hold off on making decisions, especially decisions that involve any kind of long-term commitment. When lots of people postpone decisions, economic activity slumps. Uncertainty is a cause of recessions. And there's so much uncertainty now that this recession could really be doozy."

There is no a priori reason to believe this. People might well hold off decisions because they are certain they'll make better ones when the economy turns, or that they are deferring their decisions until a more opportune time, which isn't quite the same thing as uncertainty. It's more like prudence.

"But at the same time, uncertainty is what makes capitalism go. This was the theme of University of Chicago economist Frank Knight's Risk, Uncertainty and Profit, a 1921 book that's overdue for a comeback. Wrote Knight:

With uncertainty absent, man's energies are devoted altogether to doing things; it is doubtful whether intelligence itself would exist in such a situation; in a world so built that perfect knowledge was theoretically possible, it seems likely that all organic readjustments would become mechanical, all organisms automata. With uncertainty present, doing things, the actual execution of activity, becomes in a real sense a secondary part of life; the primary problem or function is deciding what to do and how to do it.

Knight argued that making such decisions was the job of an entrepreneur, and that business profit was the reward for for being willing to act in the face of uncertainty. This means, I think, that some people who aren't sticking all their money into mattresses (or the modern equivalent, U.S. Treasuries) right now are going to make an awful lot of money over the next few years. Which people? I'm afraid I'm too uncertain to offer an answer to that."

Since you read this blog, you've probably read my link to Wittgenstein's "On Certainty", and feel, that, since you don't want to come within a million miles of dissecting certainty, you don't want to come within a billion miles of uncertainty. Well, I don't blame you. Let's look at Knight's statement anyway. Does it make any sense?

Life is inherently uncertain. Both the future and the past are uncertain. We've no choice but to act under conditions of uncertainty. What Knight really seems to be saying is that Entrepreneurs take chances that others do not, and that's how Capitalism works. Is that true?

Maybe. But it hardly distinguishes entrepreneurs from the anyone who rebelled against Rome, or went to live alone in the desert in order to find God. The fact that there risk is for profit, a better house, having no boss, etc., is just a way of saying that these individuals have chosen to face uncertainty in this particular way. Maybe we need them for capitalism, but maybe we need the people who choose another path also for capitalism, and other human desires and needs as well.

"The big mistake made in the U.S., was to create a crisis of confidence by not saving Lehman and saving A.I.G."

From the WSJ:

"MIT Sloan School of Management professor and former IMF chief economist Simon Johnson, who has contributed to Real Time Economics, helped launch the Baseline Scenario, a month-old blog with the tagline “what happened to the global economy and what we can do about it.” The Journal’s Alina Dizik spoke to him about his plan to explain the crisis to the masses. Excerpts:"

Q: What’s the main thing that you would say what went wrong and how can we fix it?

A: The big mistake made in the U.S., was to create a crisis of confidence by not saving Lehman and saving A.I.G. Now you have to focus of restoring confidence. In Western Europe they didn’t understand the vulnerability (of) the banking system. Owning up to those mistakes and coming up with coordinated responses — which include emerging markets – is important."

That's basically my position.