What have anthropologists to tell about the subprime crisis that no one else has said before?

Finance is in shambles. It has remained until now under the close supervision of economic and financial theory. In recent years, due to the overbearing dominance of views developed under the umbrella of the “Chicago School” of economics, finance has been regarded as explainable through the combination of a very simplified version of psychology: that of the “homo oeconomicus“, and of physics. The physics in question is supposed to have risen all-armoured Minerva-like out of the embarrassingly simplified psychology hitherto mentioned. This is the tenet of methodological individualism presiding nowadays over mainstream economics and financial theory.

Human nature, in the guise of the homo oeconomicus displays a number of qualities such as utilitarianism, ultimate rationality and – somewhat paradoxically combined to the two aforementioned – a pervasive herd instinct. Why this particular version of psychology? For no better reason than having been dominant at the end of the nineteenth century when a supposedly “scientific” economics emerged. This is why homo oeconomicus is so conveniently transparent to himself or herself, working out with clockwork precision in all circumstances the most rational approach that the precise quantity of information available allows – that is, unless the herd instinct prevails. Not for him the murky hesitations and self-delusion that unconscious motives convey.

Back in the nineteenth century, physics were stressing how important it was to remove subjectivity from scientific methodology, meaning the uncontrolled interaction of human beings with the subject of their inquiry. The difficulty here for economics is that when you remove from the economy the uncontrolled interaction of human beings, what is left to study is of not much interest. Here an example: price formation which economists explain as the meeting of a curve representing demand with another representing supply. Now tell me: has any anthropologist ever encountered circumstances where the status of buyer and seller is indifferent to the settling of price? Aristotle knew that reciprocal status determines price and this makes him on the contrary the anthropologist’s friend (1).

So, let us say this bluntly: human nature as envisioned by economics holds but a frightfully tenuous relationship with the type of human nature which anthropologists are familiar with.

What are then the traits of human nature which the current crisis has most prominently emphasized?

Greed is noticeably absent from the catalogue of traits pertaining to the homo oeconomicus unless it should be regarded as an inflated version of “utilitarianism”. I’m mentioning this only in passing as greed is so perspicuously at the forefront as an explanatory factor of human behaviour – especially in finance – that it hardly requires theoretical elaboration. Let’s thus concentrate instead on two other features, less blatant no doubt but most prominently at work in the current crisis: the unwarranted optimism of all agents involved and an unconscionable trust in our capacity at predicting the future.

Unwarranted optimism has made sure that the thesis holding that “things are fortunately no longer as they were in the past” has been raised to the status of dogma and subscribed to with no hint of reservation. It rests on the premise that humankind is making progress faster than the speed of light and that, despite the 1929 crisis having taken place a mere eighty years ago, the erring behaviour of the human race displayed in those days is as distant today as the Palaeolithic times. Should the current crisis turn out – God forbid! – to be worse than 1929, our belief in the indefectible progress of the human race would no doubt be compromised for at least… a full five years! Such is the spirit of the species!

Mr. Alan Greenspan, formerly head of the Federal Reserve Bank of the United States, and currently a key partner of the Paulson Credit Opportunities Fund, a hedge fund having astonishingly benefited from the American bubble popping, has been a prominent promoter of the “new economy / new finance” view where prior mishaps pertain necessarily to a distant past. “Hedging” is the financial term applying to Mr. Greenspan’s method: a financial strategy where one protects oneself against excessive exposure to risk by adopting two positions in reverse directions. In this instance, developing a particular policy based on throwing one’s arms in the air at the thought that financial bubbles could be prevented and one joining subsequently a company betting that one’s policy will fail. Here in his own words: “After more than a half-century observing numerous price bubbles evolve and deflate, I have reluctantly concluded that bubbles cannot be safely defused by monetary policy or other policy initiatives before the speculative fever breaks on its own. There was clearly little the world’s central banks could do to temper this most recent surge in human euphoria…” (2). So why not be philosophical indeed and benefit from those very unbeatable bubbles?

Mathematical models underpinning the operation of the Asset-Backed Security provide another example for overbearing optimism: we’re talking here of the infamous financial instrument backed in some unfortunate circumstances by subprime loans. What I will say here relies heavily on field notes taken in the years 1999-2007.

Briefly said, Asset-Backed Securities are debt instruments created by pooling several thousands of consumer loans in the likeness of a traditional bond. ABS may be backed by credit card debt, mortgages, student loans, aircraft leases, and so on. Literally speaking, Mortgage-Backed Securities (MBS) are asset-backed securities; historically though, MBS refer only to securities backed by “prime” mortgages, the less risky ones with high level of collateral (low Loan To Value) and high borrower credit score (3).

Models used to represent ABS’ behaviour were known to be inadequate, being in particular deprived of tools allowing simulating the impact of “triggers”, triggers being a setup allowing when the instrument is distressed to divert cash flows to locations where they are more urgently needed. Models used back in 2007 at Countrywide, the top institution in the United States granting mortgages, ergo the top institution of that type in the world at large, were deprived of the capacity of simulating “triggers”. This was not regarded though as an issue to be taken in earnest as Countrywide‘s accounting advisor – backed in this by the United States government regulator of thrifts, the OTS – regarded that lack of understanding of the products sold to trusting patrons as “industry standard,” i.e. all right. My own insistence, in my capacity of “model validator” within the Risk Management team, that such “triggers” be added to our models explains no doubt why I belonged to the first load of Countrywide employees allowed to join back the job market in October 2007. Here was at work one well-advertised dimension of the subprime crisis: the sales by investment bankers of financial products whereof they had very little understanding.

Turning now to our unconscionable trust in our capacity at predicting the future I will content myself with mentioning the way so-called “forward rates” are being used all across the financial world for making forecasts regarded as good as true about future values of interest rates. Mathematical demonstration as well as empirical data confirm that the best forecast for a “floating” interest rate, i.e. a rate for a particular maturity the value of which is determined by market forces, is its current value. This fails however to be very exciting and does not justify by itself the high wages granted until recently to “quants.” So the “industry standard” has become instead that one can derive very accurate forecasts for interest rates from the forward rates‘ curve.

A “yield curve” is a broken line connecting the current interest rates corresponding to various maturities. So you look for the current floating rates applying to borrowing for three, six, nine months, one year, three year, etc. and then connect the dots. From that curve, one can calculate – through an algorithmic technique called “bootstrapping” – some intermediary rates, implied within the current yield curve. For instance: “what rate applies if I borrow for three years in nine months from now?” The value obtained results straightforwardly from a mathematical calculation. Now, much more power is being assigned to these “forward” rates than being simply “forward”, i.e. the rate you are charged now for contracting a forward loan, such as, in our example, a promise to let you borrow for three years in nine months. Forward rates are regarded as actual predictions, and very accurate ones for that matter, of what will apply in the future.

Financial engineers with mathematical degrees from reputable higher education institutions will tell you that the current forward rate for a three year loan taken in nine months is a very good forecast for what the three year interest rate will be in nine months. It doesn’t make any mathematical or any other sense. But mind you, the fate of whole Wall Street or City institutions has been built on that basis.

What’s the explanation? My own hypothesis is that that belief derives from a special combination of arithmetic and optimism. I was once expounding to the late Professor Meyer Fortes my dismay that some of the sayings of fishermen I had lived with in Brittany seemed to be very reliable and based on empirical observation while others added to nothing more than superstition. A smile came upon his face, betraying his unswerving trust in human nature: “Paul, what would we be without hope?”

More would need to be said about the economy and finance of a more general nature, such as: “Why do business teams need to be modelled after the military type of hierarchy?” or “Why are companies built in the likeness of Sahlins’ ‘predatory lineage’? (4), i.e. as an opportunistic and colonizing entity that knows no limits? But however important, these questions go way beyond the specifics of the subprime crisis.

More relevant, although no less general, is the structure itself of the system currently undergoing a crisis: the market organisation of the economy. Little noticed is the fact that its processes have been left to the spontaneous organisation – or should one say, lack of organisation – of nature when left to its own devices: the survival of the fittest within a competitive environment. The human species has, through its own industry, brought relative peace within its political setup in the shape of democracy. The rise of democracy can be located and precisely dated. Nothing of the kind has as yet taken place with the economy. Some attempts have been made to regulate – one should say “regiment” – the economy through a simpleminded transpose of an authoritarian state structure. As one could have expected, the results were dismal but no other attempt has ever been made in earnest.

Johann Friedrich Blumenbach (1752-1840) is remembered as the true founder of Völkerkunde, usually translated as “ethnology.” Blumenbach was a fastidious classifier of human races on the evidence of their bones in the true line opened up by his forebears Linné, Tournefort and Adanson. The method turned out to be of little avail. We still owe him though the term “Caucasian” still used in the New World when referring to human beings of fair complexion. Less known are Blumenbach’s studies on domestication, detailing the changes in appearance and behaviour of species domesticated by Man. His astute observation revealed to him that Man subjected himself to the same treatment, resulting in self-domestication. Through such process we’ve managed to pacify our mutual dealings, fighting off to some extent our aggressive inclinations towards each other. Democracy displays our progress in that direction in the political realm while in the economic sphere we’ve left human nature unfettered, still short of domestication. The suffering to come from the subprime crisis will be pervasive: a strong incitement no doubt for bringing to completion that process of self-domestication.

(1) Polanyi, K., “Aristotle discovers the economy”, [1957], in G. Dalton (ed.), Primitive, Archaic and Modern Economies. Essays of Karl Polanyi, Boston: Beacon Press, 1968, 78-115; Jorion, Paul, “Aristotle’s theory of price revisited”, Dialectical Anthropology, Vol. 23, N°3 1998, 247-280.

(2) Greenspan, Alan, “The Roots of the Mortgage Crisis”, The Wall Street Journal, December 12th, 2007.

(3) There is a technical difference in the structure of MBS and ABS: the former’s credit enhancement method is subordination of junior certificates to senior certificates, the latter’s is over-collateralization (see for a more detailed explanation: The ABS and Uncle Sam.

(4) Sahlins, Marshall D., , “The Segmentary Lineage: An Organization of Predatory Expansion”, American Anthropologist, Vol. 63(2) 1961: 322-344.

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4 responses to “What have anthropologists to tell about the subprime crisis that no one else has said before?”

  1. One needs, always, to ask: “Cui Bono”?

    By linking the free market fairy to political freedom in the form of economic liberalism, first the bourgeoisie and then the monopoly capitalists have found the perfect way to hoodwink the vast majority of those who want democracy and freedom to a system that claims to reward with “an invisible hand” those whose work benefits most their fellow humans.

    The one thing we need now is to disentangle the cliche that democracy equals free markets (with little or no government regulation), and in fact that the only way to democracy is through this kind of economic arrangement. One way to show that this is not so might be to show how well such an economy worked under Nazism in Germany and Fascism in Italy, and how well it is working in the new tyranny of China.

    But these guys have us by the throat. And their toadies and theorem-provers in the academic establishment (where Nobel Prizes come from) are their lackeys. Viva Marx — for his criticism, not his solution. I am not calling for a command economy, but certainly one with more basic control. We do need a system that rewards individual initiative, but the complete ignorance (not to say haughty rejection) by traditional economists of positive feedback, lock-in, Pareto distributed income and wealth, and many other complexity visions of what real economic activity entails is an intellectual crime perpetrated for pseudo-scientific gain and admittance to the halls of the power elite.

    And who will call Alan Greenspan to account for the recent financial instrument debacle, no one. And as the Wall Street titans get their filthy hands slapped (and nothing more) during all these Senate and House hearings, what good will a few more patches of regulation do us for the future?

    Without major structural (not just regulatory) changes in our economic way of life, the gonifs (a Yiddish word for ‘crummy thieves’) with imagination and power will just think up new machinery to get rich and wait for the fall that the public will pay for. Each new crisis since the savings & loan and LTCM debacles drives new nails into the coffin of our national life. It may well be we have some breathing room now, but the next one will be so far off the Richter Scale that we may not even be able to find the pieces to pick up.

    If the Nobel science and medicine prizes were given for the same kind of useless, misleading and damaging nonsense that usually comes out of the economics prize, most scientists would not give a damn about it.

    But in some ways this country is reaping the fruits of its origins, for despite the high-toned rhetoric of the Declaration of Independence, much of what was desired by the revolutionaries was to be their own masters at exploiting the environment and their fellow humans for material gain.

  2. Like Paul, I am an admirer of Polanyi (see Halperin and Dow 1977). I see the ethnography of individual lives, and systematic analysis of complex systems as both necessary parts of cultural anthropology. In the economic crisis, the ethnographic side reveals the greed of operators in the financial institutions. The systemic side reveals the instability of the world economic system.

    Before becoming a cultural anthropologist I was an applied mathematician. Among other things I worked on the stability of solutions to systems of differential equations. The problem with them is not getting an answer, but knowing when the system will blow up, become unstable. There are mathematicians who know how to keep an airplane or bridge from shaking itself into oblivion. Evidently Wall Street had no interest in hiring these mathematicians. Don’t blame mathematics for the crisis, blame the people who perverted their work. Mathematics could just have well helped to avert the problem.

    The mathematical sciences developed by the great civilizations have helped to manage complex systems. Yet there is something else that needed to be included in this management, the maintenance of economic cooperation. Cooperation lifted the civilized economic boat to a new level. It was not capitalism but cooperation that created the wealth that civilizations now enjoy. The commanding economic gurus or our age seemed to have missed this point, which could have been included if it were not for their ideological commitment to the “free” market school. As Paul and Polanyi know, it is the power of the state over markets that keeps markets under control, keeps them working, and maintains the creation of wealth. Democracy did not do it, neither did some abstract principle of freedom, the market type, whatever that means beyond the lack of government intervention.

    I hope that democracy can add something to markets. I would opt for a dimension of equity. Equity means that a market is accessible to everyone and that the information needed to operate in it is freely available. I don’t care so much that a market is “free. I care that it is equitable. This is what a democratically inspired public can add to the control of markets. Modern democracy is a way of correcting the abuses of government. It can correct the abuses of markets.

    Evolution has equipped the human brain with powerful moral solutions to crises of cooperation. These are the reactions to the issues of morality, and justice. Most of them are not compatible with pure capitalism. But there is a wisdom in them put there by a million years of evolution of living in groups. They could have reigned in the excesses that created the crisis. But these elements of human nature can only manifest themselves in complex civilizations through ideology and religion, which have a very poor grasp of complex systems. Moral sensitivity is a biologically evolved trait and may have wait for some rather cruel Darwinian selection to take place in order to adapt it to environmental contitions created by demographic, technological, and information growth, but, hopefully, culture might change moral thinking in new ways based on the traditional thinking.

    Ideology has not mixed well into the complex system of finance. It draws on the religious structures of the brain and not on any pragmatic or scientific knowledge. It has been hidden beneath the surface. The testimony of Alan Greespan before the House Banking Committee was a perfect illustration of how this happened in one brain. He referred to mathematical models and then rejected or accepted them not with any data but how well they fitted his ideology. He had built it out of economic theory but not fact. This was not science. A scientific theory should be accepted or rejected on how well it fits the data. As the data changes, the theory should change with it. Greenspan left out behavioral data, and even the quantitative data, such as the amount of trading in credit default swaps or the difference between mortgage debt and house values that showed that there was something wrong with his ideological based theory. Science to be valid must respond to data, not to belief.

    There is a gap between the ideology of the “free”-market and the growth of extreme wealth differences. Trickle-down is nonsense. Crypto-racist ideology creeps into the gap and blames the poor for their condition. The underlying issues of the 2008 presidential election are bringing this out; however even this fact is being obscured by a media fog. Ideology and religious manipulation seem to be controlling the situation, so we cannot rely on a new ideological paradigm to solve the problem. Morality needs to be merged with systemic sciences to solve the problem. If an engineer does not care about the people who cross his or her bridge, he or she is a failure. If a financial engineer does not care about the people whose pension funds he or she is servicing, he or she is a failure too. Whoever perverts this morality is a menace.

    Halperin, Rhoda and James Dow. (1977). Peasant Livelihood: Studies in Economic Anthropology and Cultural Ecology. New York: St. Martin’s Press.

  3. il est tard et plus facile pour moi d’ exprimer la complexité en français . il est clair que l’ étude de l’ économie et de la finance en est restée à une approche mathématique simplificatrice j’ étais impressionné dans les années 70 par T de montbrial qui appliquait qques équations plus complexes à une analyse un peu plus pertinente . il n’ en demeure pas moins que les limites actuelles de ce qui existe en éco et en finance restent cantonnées aux lois normales de la statistique et aux fonctions continues . or la vie elle même n’ est que discontinuité et les théories du chaos sont bien plus explicatives de la plupart ds phénomènes que les fonctions continues dont l’ intérêt se limite à être parfaitement aptes à “prévoir” le passé;une des insuffisances de la pensée politique française réside peut être dans le fait que l’ on peut sortir de l’ ena en s’ étant limité à la connaissance de la continuité et de l’ attraction de la moyenne . comme on l’ a en plus appliqué à une vision limitée en nombre de variables , on prétend développer l’ économie en finançant le capital fixe ( comme on dit) en investissant dans la recherche publique , en créant des pépinières d’ entreprises , bref en s’ intéressant à des facteurs présents constatés sur le passé , mais non pas forcément pertinents ni décisifs. dans le domaine de la finance je découvre des approches de nature identiques , dans lesquelles on se fait plaisir en utilisant de beaux outils mathématiques , qui constituent une modélisation parmi d’ autre , cantonée à être pertinente dans un environnement particulier , appliquée sans distinctions là oùil n’ aurait pas fallu . triste pour l’ esprit , triste pour une génération qui va en souffrir en voyant brutalement confisqués les efforts d’ une vie , heureux pour un petit nombre , il est toujours sympathique en fiance de trouver une quantité significative d’ innocents pour assurer la contrepartie ;à qui appartient selon la parole , le royaume des cieux? à eux , pour peu qu’ ils n’ est pas trop conservés de ces mauvaises créances mal titrisées et mal sécuritisées