Polizeros Comment: Chairman Mao explains the mortgage crisis

I noticed a post at Polizeros about George Soros’ appearance on Bill Moyers (though I’m a huge fan of Bill Moyers Journal and have watched almost every segment going back over a year, I have not gotten around to the most recent episode yet) where Soros mentions the role of the “agent principle problem” in our current economic crisis.  The way I understand it, the agent principle problem describes the effect of the agent’s motivation or incentive in executing their task, and how it satisfies the desired objectives of a task.

In mortgage lending, as Soros points out as quoted at Polizeros (once again, I have yet to watch the program), the agents of the lenders functioned with their own compensation in mind: They originated mortgages and helped people obtain mortgages, regardless of whether it seemed like they could afford it of if they were even being truthful in their application, as they were paid their fee by origination.  They operated, as most everyone does, with their self-interest in mind (this could be extended to the lenders who were similarly striving for increased originations, who then packaged the mortgages into securities and were no longer accountable should any mortgages default.  Or should all the mortgages default).

DJ, in the comments, brings up Mao jokingly, but I believe he inadvertently brought up the perfect illustration of the agent principle problem.  Which perfectly aligns with out current crisis (at least as far as mortgage lending and the manner in which small, self-interested acts propagated into an outright crisis).

As my comment there attempts to argue (3rd comment.  The 2nd comment was just a note to Bob Morris), the individual regional leaders and those who worked with them, in attempts to reach the production goals desired and expected by Mao, falsified their performance entirely contrary to the spirit of the project.  This led to misinformation among the heads of the organization (Mao) who, not seeing the products of the agriculture or industry directly, eagerly believed his theories behind The Great Leap Forward were being proved out in execution.

He then used these inflated values to allocate the resources of his nation, believing he had massive surpluses when in fact he had none.  Stockpiling ‘excess’ grain led to starvation throughout the nation and millions dead or near that.

Because it was in no one’s individual interest (and very few people had the ability, furthermore) to tell Mao he was wrong, nor was anyone eager to disappoint him, thousands or millions actively propagated a lie in their own interests.  When it reached those above, those above took it as proof of their own genius and acted under the impression that this production number, say 10x greater than before the program, reflected a strength in production 10x greater than previous.

As mortgage lenders and the heads of banks saw the increased originations that came with loosening lending standards, they believed each origination to be of similar quality to the ones that existed before the change in standards.  And they believed that their default rates to be similar and made projections based on that.  As Mao stockpiled ‘excess’ grain, the heads of banks invested ‘excess’ capital beyond what would be required to absorb defaults.

As there was no bottom-up information being provided to those who ultimately made the forecasting, and the incentives existed for those throughout the system to lie or believe the lie, the relatively minor falsification of argicultural numbers in Mao’s China led to millions dying of famine.  The relatively minor falsification of income or size of down payment in mortgage lending these past ten years has now led to a worldwide financial collapse.

Communist or capitalist?  It doesn’t matter.  Stupidity, self-interest, and turning a blind eye to poor system design can bring about disaster just the same

(For more details, please visit the links.  I explain the actual historical characteristics a bit more thoroughly in my Polizeros comment, and the wikipedia links can provide a brief on the terms and the times)

… and the cow goes moo