The New Atlantis recently published a piece by Paul J. Cella III in which he argues that the financial crisis was the result of a modern mindset committed to rationalism and abstraction.

The modern mind broke down on account of its infatuation with abstraction. That mind is singularly susceptible to falsely imagining that ideas are more real than men. The power of the lapidary theory over the modern mind has been often remarked. The whole of the twentieth century was marked by calamitous wars driven by the imperial impulse of what Edmund Burke called “armed doctrines.” Armies, impelled by their doctrines, rolled over half the earth, leaving behind blood and smolders.

These false conceptions of reality change how we see both property and human beings. Regarding property, Cella writes:

In finance, this failure of the modern mind, its subjection to the allure of formula and abstraction, took on another aspect: the reduction of property to mathematical abstraction. The nature of property itself seemed to transform under the influence of these abstractions. The old and familiar debt instrument known as a mortgage is already an abstraction from real physical property. Pooling these instruments into complicated securities is another step of abstraction. And, in still further steps of abstraction, probabilities concerning default rates on property debt were converted into revenue streams that could be securitized. Credit-default swaps were rolled into new revenue streams and resold. Collateralized debt obligations were “squared.” Little fragments of land and housing, from neighborhoods of enormous variety all across the country, were converted by statistical abstraction into an unfathomable infrastructure of debt securities.

The complexity of these securities exceeds the power of the unaided human mind; formulas and models are necessary to apply probability rules to such enormous data sets. Property was transfigured, with help from computers, into equations. It is all very bewildering, this enfolding web of abstraction and statistical capture.

Human beings were also misconstrued by this false conception of reality:

Here we touch upon the second error the modern mind evinced in the financial crisis: a misunderstanding of human being. It is foolish in the extreme to ever imagine that any mathematical formula, no matter how subtle, can properly capture the mystery that is man. This is the simple wisdom that modern finance forgot. Our mental imaginings and computations, no matter how precise, are but approximations of the real world as it is. Our perception, even aided by machines and computers, is strictly limited. Our technical capacity is considerable, but there is still much that is beyond us.

Wall Street, at the very pinnacle of financial engineering, came to believe that derivatives on statistical abstractions were more real than men — and certainly more real than their houses. The financiers supposed that the economics of man can be perfectly figured by formula, by imitating the computation and abstraction of hard science.

All of this suggests that, at heart, we must re-conceive of economics “as if people mattered” (to borrow a phrase from E.F. Schumacher) and as if the integrity and reality of property established limits for a stable (not to mention sane) economy.

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  1. Modern neuroscientific research argues that for many categories of thinking we think emotionally and not rationally. George Soros with his theory of Reflexivity with regard to markets would support this research.

  2. This mass adherence modernist abstractions is probably why Jim Rogers general advice to short financial assets and go long all sorts of physical assets (especially agricultural land) is a good contrarian investment.

  3. And me thinking this all started ’cause the gummint was passing out its stash to people based solely on their racial status and reduced circumstances which adumbrated their inability to ever repay the loans. With this wacky Leftist policy exacerbated by the gummint hectoring bankers into making these bad loans based on the People’s (ACORN’s) Utopian Vision of “fairness” and racial justice!
    I would suggest that this is, indeed, our Kenyan president’s vision of economics “as if people mattered.” And, your children, grandchildren, et al will be paying the price….assuming they have jobs.

  4. Aristotle makes a distinction between “natural” and “unnatural exchange” that is about 3,000 years ahead of its time. The process of financial abstraction moves perfectly good economic instruments like mortgages from being natural to unnatural; the mortgage becomes more and more remote from the underlying real asset. Once in that status, everything and anything is possible, for a while.

  5. If memory serves, somewhere in “I’ll Take My Stand” one of the twelve makes a statement about the scam perpetrated on the average American by the commercial interest: convincing them that owning stock was the same as owning land — that is, owning abstract property was the same as owning real property.

    I skimmed through my copy of the book this a.m. but couldn’t locate the quote. But it’s interesting that this incipient “abstraction of property” was being recognized as such as early as 1930.

  6. Instruments like CDO-squared are not really new; bookies and football pools have been using them for years, and they’ve been illegal or wink-nod-semi-legal in that context for years.

    The difference is purely a matter of class. If you’re puffing on a Wolf Bros Rum-Soaked Crook while you’re selling a Trifecta, you’re illegal. If you’re puffing on a Partagas Robusto Robusto Robusto while you’re selling a CDS, you’re legal.

  7. So, pull all of your money out of the big investment – I mean commerical banks and put it into your local county credit union or workers’ credit union. Then attend the annual meetings of said credit union and start having an influence over the business. This article reveals a fantastic observation that has been made so many times that it seems like all we do is look for observations to make. We’ve got to move into action mode, and I think financial matters can play a large role in bringing a “local” turnaround to our economies.


    Matthew Wade

  8. The issue of abstraction and mathematical modelling isn’t as simple as suggested here,although I totally agree the economic profession has been going about its business in the wrong way. There is a difference between generalisation and abstraction. In generalisation one leaves out bits of what one can see that one is not interested in, in abstraction one leavee out a dimension so that a cube, for example, is reduced to a square, or distance to speed, or motion to a path.

    The problem with equations developed by means of statistical reduction is that they are not abstracting from reality, they are averaging measurements of generalisations which leave out at least half the story. A genuine mathematical model of an economic system is a topological mapping of paths retaining the order in which events have to happen, e.g. that we have to invest some of the surplus of what is already there in order to produce more to use in maintaining ourselves so that we can invest in production again next time round. You have to look outside mainstream economics, eg to Bernard Lonergan or James Robertson [], to find even an intuitive grasp of that.

  9. “And me thinking this all started ’cause the gummint was passing out its stash to people based solely on their racial status and reduced circumstances which adumbrated their inability to ever repay the loans.”

    Well, Bob, that theory has been very thoroughly shot down by facts. But I don’t suppose that will stop you from finding a way to blame blacks anyway.

  10. Mark, many thanks for this post. Reading Paul Cilla’s article in full led me to Amar Bhidé, who wrote:

    “Until the 1930s economists had two views of uncertainty. Frank Knight, who dominated the University of Chicago’s economics department through the late 1940s, and John Maynard Keynes highlighted uncertainties that could not be reduced to quantifiable probabilities. On the other side, followers of the Reverend Thomas Bayes developed theories in which all uncertainties were quantified, like the odds of hitting a number on a roulette wheel. … [By 1974] the world of “practical operators,” Samuelson wrote, was giving way to a “new world of the academics with their mathematical stochastic [probabilistic] processes.”

    As it happened, I did three years’ research into the reliability of reliability theory, and majored in stochastic information theory. One of the things I learned was that Bayesian theory is NOT about stochastic updating in light of new information, it is about the mutual support of estimates made by different methods (e.g. subjective and objective, theory and practice, the apparent symmetry of a die and the distribution of possible throw outcomes). A similar issue arises as to the SIGNIFICANCE of probabilities, where Pascal was on about “horses for courses” and an engineer counts the possible cost of failure BEFORE deciding whether a risk is worth taking. That a probability is a complex (two-dimensional) rather than a simple (one-dimensional) estimate is taken for granted in quality control statistics, where the worth of every assessment is assessed by means of a “confidence factor”.

    The truth is that human rationality (not just half-baked SOCIAL science) is reliably unreliable because of our using only half our brains [Chesterton’s Orthodoxy]; so that even our teachers follow devious men in white coats [Milgrim’s Obedience to Authority] like brainless sheep. But how to stop them? Barking from behind simply makes them run faster; shepherds need dogs able to run over the sheep to redirect the errant leader.

  11. Mark

    Your phrase “the scientific mindset” keeps coming back in my mind because since c.1970 I’ve been arguing there is not just ONE scientific mindset but (I then thought three but now) four, linked to personality type: hence to interests and generic type of question. As Rudyard Kipling put it:

    “I keep six honest serving men,
    They taught me all I knew;
    Their names are What? and Why? and When
    And how? and Where? and Who?”

    Modern “empirical” science took off with Sir Francis Bacon advocating taking things to bits to see How they worked. David Hume rather spoiled that by persuading people that that was impossible: all you actually could know was your own sensations and feelings. Thus after the accidental discovery of electrochemical phenomena and electric circuits, “normal” British empiricists pursued the chemical aspect and material evolution, engineers of more experimental bent asked themselves What if…? and American commerce (labelled “pragmatic” by Peirce) asked of engineers the new question: What works? In the background, “revolutionary” scientists like Faraday, Maxwell and Darwin asked themselves Why? Electric circuits led to the discovery of systematic and electromagnetic relationships, the invention of radio systems, sub-atomic physics, quantum and information theory. and information the “revolutionary” question: Why is the whole greater than its parts?

    So Why is science greater than any of these? That grossly under-rated “seer of science” G K Chesterton anticipated Gestalt theory and Kuhn’s “revolutionary science” to draw attention to the When and Who and a self-referential How of it: as When the visual imagination of himself or a Newton or Faraday or Darwin or Maxwell or Feynman looks at systematic relationships a thousand times and the next time sees what had never been seen before. This “speculative” observation and induction is only the initial phase of mature science, but Popper’s “hypothetical-deductive” method is empty without the “trials and errors” experienced by less pedantic minds eventually generating new and more fundamental hypotheses less prone to deductive error.

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