The new, digital barbarism is, in its language, comportment, thoughtlessness, and obeisance to force and power, very much like the old. And like the old, and every form of tyranny, hard or soft, it is most vulnerable to a bright light shone upon it. To call it for what it is, to examine it while paying no heed to its rich bribes and powerful coercions, to contrast it to what it presumes to replace, is to begin the long fight against it.

Very clearly, the choice is between the preeminence of the individual or of the collective, of improvisation or of routine, of the soul or of the machine. It is a choice that perhaps you have already made, without knowing it. Or perhaps it has been made for you. But it is always possible to opt in or out, because your affirmations are your own, the court of judgement your mind and heart. These are free, and you are the sovereign, always. Choose.

It would be one thing if such a revolution produced Mozarts, Einsteins, or Raphaels, but it doesn’t. It produces mouth-breathing morons in backwards baseball caps and pants that fall down; Slurpee-sucking geeks who seldom see daylight; pretentious and earnest hipsters who want you to wear bamboo socks so the world doesn’t end; women who have lizard tattoos winding from the navel to the nape of the neck; beer-drinking dufuses who pay to watch noisy cars driving around in a circle for eight hours at a stretch; and an entire race of females, now entering middle age, that speaks in North American chipmunk and seldom makes a statement without, like, a question mark at the end?

How David Beats Goliath

When underdogs break the rules.

by Malcolm Gladwell
May 11, 2009
©The New Yorker

When Vivek Ranadivé decided to coach his daughter Anjali’s basketball team, he settled on two principles. The first was that he would never raise his voice. This was National Junior Basketball—the Little League of basketball. The team was made up mostly of twelve-year-olds, and twelve-year-olds, he knew from experience, did not respond well to shouting. He would conduct business on the basketball court, he decided, the same way he conducted business at his software firm. He would speak calmly and softly, and convince the girls of the wisdom of his approach with appeals to reason and common sense.

The second principle was more important. Ranadivé was puzzled by the way Americans played basketball. He is from Mumbai. He grew up with cricket and soccer. He would never forget the first time he saw a basketball game. He thought it was mindless. Team A would score and then immediately retreat to its own end of the court. Team B would inbound the ball and dribble it into Team A’s end, where Team A was patiently waiting. Then the process would reverse itself. A basketball court was ninety-four feet long. But most of the time a team defended only about twenty-four feet of that, conceding the other seventy feet. Occasionally, teams would play a full-court press—that is, they would contest their opponent’s attempt to advance the ball up the court. But they would do it for only a few minutes at a time. It was as if there were a kind of conspiracy in the basketball world about the way the game ought to be played, and Ranadivé thought that that conspiracy had the effect of widening the gap between good teams and weak teams. Good teams, after all, had players who were tall and could dribble and shoot well; they could crisply execute their carefully prepared plays in their opponent’s end. Why, then, did weak teams play in a way that made it easy for good teams to do the very things that made them so good?

Ranadivé looked at his girls. Morgan and Julia were serious basketball players. But Nicky, Angela, Dani, Holly, Annika, and his own daughter, Anjali, had never played the game before. They weren’t all that tall. They couldn’t shoot. They weren’t particularly adept at dribbling. They were not the sort who played pickup games at the playground every evening. Most of them were, as Ranadivé says, “little blond girls” from Menlo Park and Redwood City, the heart of Silicon Valley. These were the daughters of computer programmers and people with graduate degrees. They worked on science projects, and read books, and went on ski vacations with their parents, and dreamed about growing up to be marine biologists. Ranadivé knew that if they played the conventional way—if they let their opponents dribble the ball up the court without opposition—they would almost certainly lose to the girls for whom basketball was a passion. Ranadivé came to America as a seventeen-year-old, with fifty dollars in his pocket. He was not one to accept losing easily. His second principle, then, was that his team would play a real full-court press, every game, all the time. The team ended up at the national championships. “It was really random,” Anjali Ranadivé said. “I mean, my father had never played basketball before.”

David’s victory over Goliath, in the Biblical account, is held to be an anomaly. It was not. Davids win all the time. The political scientist Ivan Arreguín-Toft recently looked at every war fought in the past two hundred years between strong and weak combatants. The Goliaths, he found, won in 71.5 per cent of the cases. That is a remarkable fact. Arreguín-Toft was analyzing conflicts in which one side was at least ten times as powerful—in terms of armed might and population—as its opponent, and even in those lopsided contests the underdog won almost a third of the time.

In the Biblical story of David and Goliath, David initially put on a coat of mail and a brass helmet and girded himself with a sword: he prepared to wage a conventional battle of swords against Goliath. But then he stopped. “I cannot walk in these, for I am unused to it,” he said (in Robert Alter’s translation), and picked up those five smooth stones. What happened, Arreguín-Toft wondered, when the underdogs likewise acknowledged their weakness and chose an unconventional strategy? He went back and re-analyzed his data. In those cases, David’s winning percentage went from 28.5 to 63.6. When underdogs choose not to play by Goliath’s rules, they win, Arreguín-Toft concluded, “even when everything we think we know about power says they shouldn’t.”

Consider the way T. E. Lawrence (or, as he is better known, Lawrence of Arabia) led the revolt against the Ottoman Army occupying Arabia near the end of the First World War. The British were helping the Arabs in their uprising, and the initial focus was Medina, the city at the end of a long railroad that the Turks had built, running south from Damascus and down through the Hejaz desert. The Turks had amassed a large force in Medina, and the British leadership wanted Lawrence to gather the Arabs and destroy the Turkish garrison there, before the Turks could threaten the entire region.

But when Lawrence looked at his ragtag band of Bedouin fighters he realized that a direct attack on Medina would never succeed. And why did taking the city matter, anyway? The Turks sat in Medina “on the defensive, immobile.” There were so many of them, consuming so much food and fuel and water, that they could hardly make a major move across the desert. Instead of attacking the Turks at their point of strength, Lawrence reasoned, he ought to attack them where they were weak—along the vast, largely unguarded length of railway line that was their connection to Damascus. Instead of focussing his attention on Medina, he should wage war over the broadest territory possible.

The Bedouins under Lawrence’s command were not, in conventional terms, skilled troops. They were nomads. Sir Reginald Wingate, one of the British commanders in the region, called them “an untrained rabble, most of whom have never fired a rifle.” But they were tough and they were mobile. The typical Bedouin soldier carried no more than a rifle, a hundred rounds of ammunition, forty-five pounds of flour, and a pint of drinking water, which meant that he could travel as much as a hundred and ten miles a day across the desert, even in summer. “Our cards were speed and time, not hitting power,” Lawrence wrote. “Our largest available resources were the tribesmen, men quite unused to formal warfare, whose assets were movement, endurance, individual intelligence, knowledge of the country, courage.” The eighteenth-century general Maurice de Saxe famously said that the art of war was about legs, not arms, and Lawrence’s troops were all legs. In one typical stretch, in the spring of 1917, his men dynamited sixty rails and cut a telegraph line at Buair on March 24th, sabotaged a train and twenty-five rails at Abu al-Naam on March 25th, dynamited fifteen rails and cut a telegraph line at Istabl Antar on March 27th, raided a Turkish garrison and derailed a train on March 29th, returned to Buair and sabotaged the railway line again on March 31st, dynamited eleven rails at Hediah on April 3rd, raided the train line in the area of Wadi Dhaiji on April 4th and 5th, and attacked twice on April 6th.

Lawrence’s masterstroke was an assault on the port town of Aqaba. The Turks expected an attack from British ships patrolling the waters of the Gulf of Aqaba to the west. Lawrence decided to attack from the east instead, coming at the city from the unprotected desert, and to do that he led his men on an audacious, six-hundred-mile loop—up from the Hejaz, north into the Syrian desert, and then back down toward Aqaba. This was in summer, through some of the most inhospitable land in the Middle East, and Lawrence tacked on a side trip to the outskirts of Damascus, in order to mislead the Turks about his intentions. “This year the valley seemed creeping with horned vipers and puff-adders, cobras and black snakes,” Lawrence writes in “The Seven Pillars of Wisdom” of one stage in the journey:

Twice puff-adders came twisting into the alert ring of our debating coffee-circle. Three of our men died of bites; four recovered after great fear and pain, and a swelling of the poisoned limb. Howeitat treatment was to bind up the part with snake-skin plaster and read chapters of the Koran to the sufferer until he died

When they finally arrived at Aqaba, Lawrence’s band of several hundred warriors killed or captured twelve hundred Turks, and lost only two men. The Turks simply did not think that their opponent would be mad enough to come at them from the desert. This was Lawrence’s great insight. David can beat Goliath by substituting effort for ability—and substituting effort for ability turns out to be a winning formula for underdogs in all walks of life, including little blond-haired girls on the basketball court.

Vivek Ranadivé is an elegant man, slender and fine-boned, with impeccable manners and a languorous walk. His father was a pilot who was jailed by Indira Gandhi, he says, because he wouldn’t stop challenging the safety of India’s planes. Ranadivé went to M.I.T., because he saw a documentary on the school and decided that it was perfect for him. This was in the nineteen-seventies, when going abroad for undergraduate study required the Indian government to authorize the release of foreign currency, and Ranadivé camped outside the office of the governor of the Reserve Bank of India until he got his way. The Ranadivés are relentless.

In 1985, Ranadivé founded a software company in Silicon Valley devoted to what in the computer world is known as “real time” processing. If a businessman waits until the end of the month to collect and count his receipts, he’s “batch processing.” There is a gap between the events in the company—sales—and his understanding of those events. Wall Street used to be the same way. The information on which a trader based his decisions was scattered across a number of databases. The trader would collect information from here and there, collate and analyze it, and then make a trade. What Ranadivé’s company, TIBCO, did was to consolidate those databases into one stream, so that the trader could collect all the data he wanted instantaneously. Batch processing was replaced by real-time processing. Today, TIBCO’s software powers most of the trading floors on Wall Street.

Ranadivé views this move from batch to real time as a sort of holy mission. The shift, to his mind, is one of kind, not just of degree. “We’ve been working with some airlines,” he said. “You know, when you get on a plane and your bag doesn’t, they actually know right away that it’s not there. But no one tells you, and a big part of that is that they don’t have all their information in one place. There are passenger systems that know where the passenger is. There are aircraft and maintenance systems that track where the plane is and what kind of shape it’s in. Then, there are baggage systems and ticketing systems—and they’re all separate. So you land, you wait at the baggage terminal, and it doesn’t show up.” Everything bad that happens in that scenario, Ranadivé maintains, happens because of the lag between the event (the luggage doesn’t make it onto the plane) and the response (the airline tells you that your luggage didn’t make the plane). The lag is why you’re angry. The lag is why you had to wait, fruitlessly, at baggage claim. The lag is why you vow never to fly that airline again. Put all the databases together, and there’s no lag. “What we can do is send you a text message the moment we know your bag didn’t make it,” Ranadivé said, “telling you we’ll ship it to your house.”

A few years ago, Ranadivé wrote a paper arguing that even the Federal Reserve ought to make its decisions in real time—not once every month or two. “Everything in the world is now real time,” he said. “So when a certain type of shoe isn’t selling at your corner shop, it’s not six months before the guy in China finds out. It’s almost instantaneous, thanks to my software. The world runs in real time, but government runs in batch. Every few months, it adjusts. Its mission is to keep the temperature comfortable in the economy, and, if you were to do things the government’s way in your house, then every few months you’d turn the heater either on or off, overheating or underheating your house.” Ranadivé argued that we ought to put the economic data that the Fed uses into a big stream, and write a computer program that sifts through those data, the moment they are collected, and make immediate, incremental adjustments to interest rates and the money supply. “It can all be automated,” he said. “Look, we’ve had only one soft landing since the Second World War. Basically, we’ve got it wrong every single time.”

You can imagine what someone like Alan Greenspan or Ben Bernanke might say about that idea. Such people are powerfully invested in the notion of the Fed as a Solomonic body: that pause of five or eight weeks between economic adjustments seems central to the process of deliberation. To Ranadivé, though, “deliberation” just prettifies the difficulties created by lag. The Fed has to deliberate because it’s several weeks behind, the same way the airline has to bow and scrape and apologize because it waited forty-five minutes to tell you something that it could have told you the instant you stepped off the plane.

Is it any wonder that Ranadivé looked at the way basketball was played and found it mindless? A professional basketball game was forty-eight minutes long, divided up into alternating possessions of roughly twenty seconds: back and forth, back and forth. But a good half of each twenty-second increment was typically taken up with preliminaries and formalities. The point guard dribbled the ball up the court. He stood above the top of the key, about twenty-four feet from the opposing team’s basket. He called out a play that the team had choreographed a hundred times in practice. It was only then that the defending team sprang into action, actively contesting each pass and shot. Actual basketball took up only half of that twenty-second interval, so that a game’s real length was not forty-eight minutes but something closer to twenty-four minutes—and that twenty-four minutes of activity took place within a narrowly circumscribed area. It was as formal and as convention-bound as an eighteenth-century quadrille. The supporters of that dance said that the defensive players had to run back to their own end, in order to compose themselves for the arrival of the other team. But the reason they had to compose themselves, surely, was that by retreating they allowed the offense to execute a play that it had practiced to perfection. Basketball was batch!

Insurgents, though, operate in real time. Lawrence hit the Turks, in that stretch in the spring of 1917, nearly every day, because he knew that the more he accelerated the pace of combat the more the war became a battle of endurance—and endurance battles favor the insurgent. “And it happened as the Philistine arose and was drawing near David that David hastened and ran out from the lines toward the Philistine,” the Bible says. “And he reached his hand into the pouch and took from there a stone and slung it and struck the Philistine in his forehead.” The second sentence—the slingshot part—is what made David famous. But the first sentence matters just as much. David broke the rhythm of the encounter. He speeded it up. “The sudden astonishment when David sprints forward must have frozen Goliath, making him a better target,” the poet and critic Robert Pinsky writes in “The Life of David.” Pinsky calls David a “point guard ready to flick the basketball here or there.” David pressed. That’s what Davids do when they want to beat Goliaths.

Ranadivé’s basketball team played in the National Junior Basketball seventh-and-eighth-grade division, representing Redwood City. The girls practiced at Paye’s Place, a gym in nearby San Carlos. Because Ranadivé had never played basketball, he recruited a series of experts to help him. The first was Roger Craig, the former all-pro running back for the San Francisco 49ers, who is also TIBCO’s director of business development. As a football player, Craig was legendary for the off-season hill workouts he put himself through. Most of his N.F.L. teammates are now hobbling around golf courses. He has run seven marathons. After Craig signed on, he recruited his daughter Rometra, who played Division I basketball at Duke and U.S.C. Rometra was the kind of person you assigned to guard your opponent’s best player in order to shut her down. The girls loved Rometra. “She has always been like my big sister,” Anjali Ranadivé said. “It was so awesome to have her along.”

Redwood City’s strategy was built around the two deadlines that all basketball teams must meet in order to advance the ball. The first is the inbounds pass. When one team scores, a player from the other team takes the ball out of bounds and has five seconds to pass it to a teammate on the court. If that deadline is missed, the ball goes to the other team. Usually, that’s not an issue, because teams don’t contest the inbounds pass. They run back to their own end. Redwood City did not. Each girl on the team closely shadowed her counterpart. When some teams play the press, the defender plays behind the offensive player she’s guarding, to impede her once she catches the ball. The Redwood City girls, by contrast, played in front of their opponents, to prevent them from catching the inbounds pass in the first place. And they didn’t guard the player throwing the ball in. Why bother? Ranadivé used that extra player as a floater, who could serve as a second defender against the other team’s best player. “Think about football,” Ranadivé said. “The quarterback can run with the ball. He has the whole field to throw to, and it’s still damned difficult to complete a pass.” Basketball was harder. A smaller court. A five-second deadline. A heavier, bigger ball. As often as not, the teams Redwood City was playing against simply couldn’t make the inbounds pass within the five-second limit. Or the inbounding player, panicked by the thought that her five seconds were about to be up, would throw the ball away. Or her pass would be intercepted by one of the Redwood City players. Ranadivé’s girls were maniacal.

The second deadline requires a team to advance the ball across mid-court, into its opponent’s end, within ten seconds, and if Redwood City’s opponents met the first deadline the girls would turn their attention to the second. They would descend on the girl who caught the inbounds pass and “trap” her. Anjali was the designated trapper. She’d sprint over and double-team the dribbler, stretching her long arms high and wide. Maybe she’d steal the ball. Maybe the other player would throw it away in a panic—or get bottled up and stalled, so that the ref would end up blowing the whistle. “When we first started out, no one knew how to play defense or anything,” Anjali said. “So my dad said the whole game long, ‘Your job is to guard someone and make sure they never get the ball on inbounds plays.’ It’s the best feeling in the world to steal the ball from someone. We would press and steal, and do that over and over again. It made people so nervous. There were teams that were a lot better than us, that had been playing a long time, and we would beat them.”

The Redwood City players would jump ahead 4–0, 6–0, 8–0, 12–0. One time, they led 25–0. Because they typically got the ball underneath their opponent’s basket, they rarely had to take low-percentage, long-range shots that required skill and practice. They shot layups. In one of the few games that Redwood City lost that year, only four of the team’s players showed up. They pressed anyway. Why not? They lost by three points.

“What that defense did for us is that we could hide our weaknesses,” Rometra Craig said. She helped out once Redwood City advanced to the regional championships. “We could hide the fact that we didn’t have good outside shooters. We could hide the fact that we didn’t have the tallest lineup, because as long as we played hard on defense we were getting steals and getting easy layups. I was honest with the girls. I told them, ‘We’re not the best basketball team out there.’ But they understood their roles.” A twelve-year-old girl would go to war for Rometra. “They were awesome,” she said.

Lawrence attacked the Turks where they were weak—the railroad—and not where they were strong, Medina. Redwood City attacked the inbounds pass, the point in a game where a great team is as vulnerable as a weak one. Lawrence extended the battlefield over as large an area as possible. So did the girls of Redwood City. They defended all ninety-four feet. The full-court press is legs, not arms. It supplants ability with effort. It is basketball for those “quite unused to formal warfare, whose assets were movement, endurance, individual intelligence . . . courage.”

“It’s an exhausting strategy,” Roger Craig said. He and Ranadivé were in a TIBCO conference room, reminiscing about their dream season. Ranadivé was at the whiteboard, diagramming the intricacies of the Redwood City press. Craig was sitting at the table.

“My girls had to be more fit than the others,” Ranadivé said.

“He used to make them run,” Craig said, nodding approvingly.

“We followed soccer strategy in practice,” Ranadivé said. “I would make them run and run and run. I couldn’t teach them skills in that short period of time, and so all we did was make sure they were fit and had some basic understanding of the game. That’s why attitude plays such a big role in this, because you’re going to get tired.” He turned to Craig. “What was our cheer again?”

The two men thought for a moment, then shouted out happily, in unison, “One, two, three, ATTITUDE!”

That was it! The whole Redwood City philosophy was based on a willingness to try harder than anyone else.

“One time, some new girls joined the team,” Ranadivé said, “and so in the first practice I had I was telling them, ‘Look, this is what we’re going to do,’ and I showed them. I said, ‘It’s all about attitude.’ And there was this one new girl on the team, and I was worried that she wouldn’t get the whole attitude thing. Then we did the cheer and she said, ‘No, no, it’s not One, two three, ATTITUDE. It’s One, two, three, attitude HAH ’ ”—at which point Ranadivé and Craig burst out laughing.

In January of 1971, the Fordham University Rams played a basketball game against the University of Massachusetts Redmen. The game was in Amherst, at the legendary arena known as the Cage, where the Redmen hadn’t lost since December of 1969. Their record was 11–1. The Redmen’s star was none other than Julius Erving—Dr. J. The UMass team was very, very good. Fordham, by contrast, was a team of scrappy kids from the Bronx and Brooklyn. Their center had torn up his knee the first week of the season, which meant that their tallest player was six feet five. Their starting forward—and forwards are typically almost as tall as centers—was Charlie Yelverton, who was six feet two. But from the opening buzzer the Rams launched a full-court press, and never let up. “We jumped out to a thirteen-to-six lead, and it was a war the rest of the way,” Digger Phelps, the Fordham coach at the time, recalls. “These were tough city kids. We played you ninety-four feet. We knew that sooner or later we were going to make you crack.” Phelps sent in one indefatigable Irish or Italian kid from the Bronx after another to guard Erving, and, one by one, the indefatigable Irish and Italian kids fouled out. None of them were as good as Erving. It didn’t matter. Fordham won, 87–79.

In the world of basketball, there is one story after another like this about legendary games where David used the full-court press to beat Goliath. Yet the puzzle of the press is that it has never become popular. People look at upsets like Fordham over UMass and call them flukes. Basketball sages point out that the press can be beaten by a well-coached team with adept ball handlers and astute passers—and that is true. Ranadivé readily admitted that all an opposing team had to do to beat Redwood City was press back: the girls were not good enough to handle their own medicine. Playing insurgent basketball did not guarantee victory. It was simply the best chance an underdog had of beating Goliath. If Fordham had played UMass the conventional way, it would have lost by thirty points. And yet somehow that lesson has escaped the basketball establishment.

What did Digger Phelps do, the season after his stunning upset of UMass? He never used the full-court press the same way again. The UMass coach, Jack Leaman, was humbled in his own gym by a bunch of street kids. Did he learn from his defeat and use the press himself the next time he had a team of underdogs? He did not.

The only person who seemed to have absorbed the lessons of that game was a skinny little guard on the UMass freshman team named Rick Pitino. He didn’t play that day. He watched, and his eyes grew wide. Even now, thirty-eight years later, he can name, from memory, nearly every player on the Fordham team: Yelverton, Sullivan, Mainor, Charles, Zambetti. “They came in with the most unbelievable pressing team I’d ever seen,” Pitino said. “Five guys between six feet five and six feet. It was unbelievable how they covered ground. I studied it. There is no way they should have beaten us. Nobody beat us at the Cage.”

Pitino became the head coach at Boston University in 1978, when he was twenty-five years old, and used the press to take the school to its first N.C.A.A. tournament appearance in twenty-four years. At his next head-coaching stop, Providence College, Pitino took over a team that had gone 11–20 the year before. The players were short and almost entirely devoid of talent—a carbon copy of the Fordham Rams. They pressed, and ended up one game away from playing for the national championship. At the University of Kentucky, in the mid-nineteen-nineties, Pitino took his team to the Final Four three times—and won a national championship—with full-court pressure, and then rode the full-court press back to the Final Four in 2005, as the coach at the University of Louisville. This year, his Louisville team entered the N.C.A.A. tournament ranked No. 1 in the land. College coaches of Pitino’s calibre typically have had numerous players who have gone on to be bona-fide all-stars at the professional level. In his many years of coaching, Pitino has had one, Antoine Walker. It doesn’t matter. Every year, he racks up more and more victories.

“The greatest example of the press I’ve ever coached was my Kentucky team in ’96, when we played L.S.U.,” Pitino said. He was at the athletic building at the University of Louisville, in a small room filled with television screens, where he watches tapes of opponents’ games. “Do we have that tape?” Pitino called out to an assistant. He pulled a chair up close to one of the monitors. The game began with Kentucky stealing the ball from L.S.U., deep in L.S.U.’s end. Immediately, the ball was passed to Antoine Walker, who cut to the basket for a layup. L.S.U. got the ball back. Kentucky stole it again. Another easy basket by Walker. “Walker had almost thirty points at halftime,” Pitino said. “He dunked it almost every time. When we steal, he just runs to the basket.” The Kentucky players were lightning quick and long-armed, and swarmed around the L.S.U. players, arms flailing. It was mayhem. Five minutes in, it was clear that L.S.U. was panicking.

Pitino trains his players to look for what he calls the “rush state” in their opponents—that moment when the player with the ball is shaken out of his tempo—and L.S.U. could not find a way to get out of the rush state. “See if you find one play that L.S.U. managed to run,” Pitino said. You couldn’t. The L.S.U. players struggled to get the ball inbounds, and, if they did that, they struggled to get the ball over mid-court, and on those occasions when they managed both those things they were too overwhelmed and exhausted to execute their offense the way they had been trained to. “We had eighty-six points at halftime,” Pitino went on—eighty-six points being, of course, what college basketball teams typically score in an entire game. “And I think we’d forced twenty-three turnovers at halftime,” twenty-three turnovers being what college basketball teams might force in two games. “I love watching this,” Pitino said. He had a faraway look in his eyes. “Every day, you dream about getting a team like this again.” So why are there no more than a handful of college teams who use the full-court press the way Pitino does?

Arreguín-Toft found the same puzzling pattern. When an underdog fought like David, he usually won. But most of the time underdogs didn’t fight like David. Of the two hundred and two lopsided conflicts in Arreguín-Toft’s database, the underdog chose to go toe to toe with Goliath the conventional way a hundred and fifty-two times—and lost a hundred and nineteen times. In 1809, the Peruvians fought the Spanish straight up and lost; in 1816, the Georgians fought the Russians straight up and lost; in 1817, the Pindaris fought the British straight up and lost; in the Kandyan rebellion of 1817, the Sri Lankans fought the British straight up and lost; in 1823, the Burmese chose to fight the British straight up and lost. The list of failures was endless. In the nineteen-forties, the Communist insurgency in Vietnam bedevilled the French until, in 1951, the Viet Minh strategist Vo Nguyen Giap switched to conventional warfare—and promptly suffered a series of defeats. George Washington did the same in the American Revolution, abandoning the guerrilla tactics that had served the colonists so well in the conflict’s early stages. “As quickly as he could,” William Polk writes in “Violent Politics,” a history of unconventional warfare, Washington “devoted his energies to creating a British-type army, the Continental Line. As a result, he was defeated time after time and almost lost the war.”

It makes no sense, unless you think back to that Kentucky-L.S.U. game and to Lawrence’s long march across the desert to Aqaba. It is easier to dress soldiers in bright uniforms and have them march to the sound of a fife-and-drum corps than it is to have them ride six hundred miles through the desert on the back of a camel. It is easier to retreat and compose yourself after every score than swarm about, arms flailing. We tell ourselves that skill is the precious resource and effort is the commodity. It’s the other way around. Effort can trump ability—legs, in Saxe’s formulation, can overpower arms—because relentless effort is in fact something rarer than the ability to engage in some finely tuned act of motor coördination.

“I have so many coaches come in every year to learn the press,” Pitino said. Louisville was the Mecca for all those Davids trying to learn how to beat Goliaths. “Then they e-mail me. They tell me they can’t do it. They don’t know if they have the bench. They don’t know if the players can last.” Pitino shook his head. “We practice every day for two hours straight,” he went on. “The players are moving almost ninety-eight per cent of the practice. We spend very little time talking. When we make our corrections”—that is, when Pitino and his coaches stop play to give instruction—“they are seven-second corrections, so that our heart rate never rests. We are always working.” Seven seconds! The coaches who came to Louisville sat in the stands and watched that ceaseless activity and despaired. The prospect of playing by David’s rules was too daunting. They would rather lose.

In 1981, a computer scientist from Stanford University named Doug Lenat entered the Traveller Trillion Credit Squadron tournament, in San Mateo, California. It was a war game. The contestants had been given several volumes of rules, well beforehand, and had been asked to design their own fleet of warships with a mythical budget of a trillion dollars. The fleets then squared off against one another in the course of a weekend. “Imagine this enormous auditorium area with tables, and at each table people are paired off,” Lenat said. “The winners go on and advance. The losers get eliminated, and the field gets smaller and smaller, and the audience gets larger and larger.”

Lenat had developed an artificial-intelligence program that he called Eurisko, and he decided to feed his program the rules of the tournament. Lenat did not give Eurisko any advice or steer the program in any particular strategic direction. He was not a war-gamer. He simply let Eurisko figure things out for itself. For about a month, for ten hours every night on a hundred computers at Xerox PARC, in Palo Alto, Eurisko ground away at the problem, until it came out with an answer. Most teams fielded some version of a traditional naval fleet—an array of ships of various sizes, each well defended against enemy attack. Eurisko thought differently. “The program came up with a strategy of spending the trillion on an astronomical number of small ships like P.T. boats, with powerful weapons but absolutely no defense and no mobility,” Lenat said. “They just sat there. Basically, if they were hit once they would sink. And what happened is that the enemy would take its shots, and every one of those shots would sink our ships. But it didn’t matter, because we had so many.” Lenat won the tournament in a runaway.

The next year, Lenat entered once more, only this time the rules had changed. Fleets could no longer just sit there. Now one of the criteria of success in battle was fleet “agility.” Eurisko went back to work. “What Eurisko did was say that if any of our ships got damaged it would sink itself—and that would raise fleet agility back up again,” Lenat said. Eurisko won again.

Eurisko was an underdog. The other gamers were people steeped in military strategy and history. They were the sort who could tell you how Wellington had outfoxed Napoleon at Waterloo, or what exactly happened at Antietam. They had been raised on Dungeons and Dragons. They were insiders. Eurisko, on the other hand, knew nothing but the rule book. It had no common sense. As Lenat points out, a human being understands the meaning of the sentences “Johnny robbed a bank. He is now serving twenty years in prison,” but Eurisko could not, because as a computer it was perfectly literal; it could not fill in the missing step—“Johnny was caught, tried, and convicted.” Eurisko was an outsider. But it was precisely that outsiderness that led to Eurisko’s victory: not knowing the conventions of the game turned out to be an advantage.

“Eurisko was exposing the fact that any finite set of rules is going to be a very incomplete approximation of reality,” Lenat explained. “What the other entrants were doing was filling in the holes in the rules with real-world, realistic answers. But Eurisko didn’t have that kind of preconception, partly because it didn’t know enough about the world.” So it found solutions that were, as Lenat freely admits, “socially horrifying”: send a thousand defenseless and immobile ships into battle; sink your own ships the moment they get damaged.

This is the second half of the insurgent’s creed. Insurgents work harder than Goliath. But their other advantage is that they will do what is “socially horrifying”—they will challenge the conventions about how battles are supposed to be fought. All the things that distinguish the ideal basketball player are acts of skill and coördination. When the game becomes about effort over ability, it becomes unrecognizable—a shocking mixture of broken plays and flailing limbs and usually competent players panicking and throwing the ball out of bounds. You have to be outside the establishment—a foreigner new to the game or a skinny kid from New York at the end of the bench—to have the audacity to play it that way. George Washington couldn’t do it. His dream, before the war, was to be a British Army officer, finely turned out in a red coat and brass buttons. He found the guerrillas who had served the American Revolution so well to be “an exceeding dirty and nasty people.” He couldn’t fight the establishment, because he was the establishment.

T. E. Lawrence, by contrast, was the farthest thing from a proper British Army officer. He did not graduate with honors from Sandhurst. He was an archeologist by trade, a dreamy poet. He wore sandals and full Bedouin dress when he went to see his military superiors. He spoke Arabic like a native, and handled a camel as if he had been riding one all his life. And David, let’s not forget, was a shepherd. He came at Goliath with a slingshot and staff because those were the tools of his trade. He didn’t know that duels with Philistines were supposed to proceed formally, with the crossing of swords. “When the lion or the bear would come and carry off a sheep from the herd, I would go out after him and strike him down and rescue it from his clutches,” David explained to Saul. He brought a shepherd’s rules to the battlefield.

The price that the outsider pays for being so heedless of custom is, of course, the disapproval of the insider. Why did the Ivy League schools of the nineteen-twenties limit the admission of Jewish immigrants? Because they were the establishment and the Jews were the insurgents, scrambling and pressing and playing by immigrant rules that must have seemed to the Wasp élite of the time to be socially horrifying. “Their accomplishment is well over a hundred per cent of their ability on account of their tremendous energy and ambition,” the dean of Columbia College said of the insurgents from Brooklyn, the Bronx, and the Lower East Side. He wasn’t being complimentary. Goliath does not simply dwarf David. He brings the full force of social convention against him; he has contempt for David.

“In the beginning, everyone laughed at our fleet,” Lenat said. “It was really embarrassing. People felt sorry for us. But somewhere around the third round they stopped laughing, and some time around the fourth round they started complaining to the judges. When we won again, some people got very angry, and the tournament directors basically said that it was not really in the spirit of the tournament to have these weird computer-designed fleets winning. They said that if we entered again they would stop having the tournament. I decided the best thing to do was to graciously bow out.”

It isn’t surprising that the tournament directors found Eurisko’s strategies beyond the pale. It’s wrong to sink your own ships, they believed. And they were right. But let’s remember who made that rule: Goliath. And let’s remember why Goliath made that rule: when the world has to play on Goliath’s terms, Goliath wins.

The trouble for Redwood City started early in the regular season. The opposing coaches began to get angry. There was a sense that Redwood City wasn’t playing fair—that it wasn’t right to use the full-court press against twelve-year-old girls, who were just beginning to grasp the rudiments of the game. The point of basketball, the dissenting chorus said, was to learn basketball skills. Of course, you could as easily argue that in playing the press a twelve-year-old girl learned something much more valuable—that effort can trump ability and that conventions are made to be challenged. But the coaches on the other side of Redwood City’s lopsided scores were disinclined to be so philosophical.

“There was one guy who wanted to have a fight with me in the parking lot,” Ranadivé said. “He was this big guy. He obviously played football and basketball himself, and he saw that skinny, foreign guy beating him at his own game. He wanted to beat me up.”

Roger Craig says that he was sometimes startled by what he saw. “The other coaches would be screaming at their girls, humiliating them, shouting at them. They would say to the refs—‘That’s a foul! That’s a foul!’ But we weren’t fouling. We were just playing aggressive defense.”

“My girls were all blond-haired white girls,” Ranadivé said. “My daughter is the closest we have to a black girl, because she’s half-Indian. One time, we were playing this all-black team from East San Jose. They had been playing for years. These were born-with-a-basketball girls. We were just crushing them. We were up something like twenty to zero. We wouldn’t even let them inbound the ball, and the coach got so mad that he took a chair and threw it. He started screaming at his girls, and of course the more you scream at girls that age the more nervous they get.” Ranadivé shook his head: never, ever raise your voice. “Finally, the ref physically threw him out of the building. I was afraid. I think he couldn’t stand it because here were all these blond-haired girls who were clearly inferior players, and we were killing them.”

At the nationals, the Redwood City girls won their first two games. In the third round, their opponents were from somewhere deep in Orange County. Redwood City had to play them on their own court, and the opponents supplied their own referee as well. The game was at eight o’clock in the morning. The Redwood City players left their hotel at six, to beat the traffic. It was downhill from there. The referee did not believe in “One, two, three, attitude HAH.” He didn’t think that playing to deny the inbounds pass was basketball. He began calling one foul after another.

“They were touch fouls,” Craig said. Ticky-tacky stuff. The memory was painful.

“My girls didn’t understand,” Ranadivé said. “The ref called something like four times as many fouls on us as on the other team.”

“People were booing,” Craig said. “It was bad.”

“A two-to-one ratio is understandable, but a ratio of four to one?” Ranadivé shook his head.

“One girl fouled out.”

“We didn’t get blown out. There was still a chance to win. But . . .”

Ranadivé called the press off. He had to. The Redwood City players retreated to their own end, and passively watched as their opponents advanced down the court. They did not run. They paused and deliberated between each possession. They played basketball the way basketball is supposed to be played, and they lost—but not before making Goliath wonder whether he was a giant, after all. ♦

The Madness of Crowds

John Steele Gordon
©CommentaryMagazine.com
November 2008


Fueled by easy credit, the real-estate market had been rising swiftly for some years. Members of Congress were determined to assure the continuation of that easy credit. Suddenly, the party came to a devastating halt. Defaults multiplied, banks began to fail. Soon the economic troubles spread beyond real estate. Depression stalked the land.

The year was 1836.

The nexus of excess speculation, political mischief, and financial disaster—the same tangle that led to our present economic crisis—has been long and deep. Its nature has changed over the years as Americans have endeavored, with varying success, to learn from the mistakes of the past. But it has always been there, and the commonalities from era to era are stark and stunning. Given the recurrence of these themes over the course of three centuries, there is every reason to believe that similar calamities will beset the system as long as human nature and human action play a role in the workings of markets.

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Let us begin our account of the catastrophic effects of speculative bubbles and political gamesmanship with the collapse of 1836. Thanks to a growing population, prosperity, and the advancing frontier, poorly regulated state banks had been multiplying throughout the 1830’s. In those days, chartered banks issued paper money, called banknotes, backed by their reserves. From 1828 to 1836, the amount in circulation had tripled, from $48 million to $149 million. Bank loans, meanwhile, had almost quadrupled to $525 million. Many of the loans went to finance speculation in real estate.

Much of this easy-credit-induced speculation had been caused, as it happens, by President Andrew Jackson. This was a terrific irony, since Jackson, who served as President from 1829 until 1837, hated speculation, paper money, and banks. His crusade to destroy the Second Bank of the United States, an obsession that led him to withdraw all federal funds from its coffers in 1833, removed the primary source of bank discipline in the United States. Jackson had transferred those federal funds to state banks, thereby enabling their outstanding loans to swell.

The real-estate component of the crisis began to take shape in 1832, when sales by the government of land on the frontier were running about $2.5 million a year. Some of the buyers were prospective settlers, but most were speculators hoping to turn a profit by borrowing most of the money needed and waiting for swiftly-rising values to put them in the black. By 1836, annual land sales totaled $25 million; in the summer of that year, they were running at the astonishing rate of $5 million a month.

While Jackson, who was not economically sophisticated, did not grasp how his own actions had fueled the speculation, he understood perfectly well what was happening. With characteristic if ill-advised decisiveness, he moved to stop it. Since members both of Congress and of his cabinet were personally involved in the speculation, he faced fierce opposition. But in July, as soon as Congress adjourned for the year, Jackson issued an executive order known as the “specie circular.” This forbade the Land Office to accept anything but gold and silver (i.e., specie) in payment for land. Jackson hoped that the move would dampen the speculation, and it did. Unfortunately, it did far more: people began to exchange their banknotes for gold and silver. As the demand for specie soared, the banks called in loans in order to stay liquid.

The result was a credit crunch. Interest rates that had been at 7 percent a year rose to 2 and even 3 percent a month. Weaker, overextended banks began to fail. Bankruptcies spread. Even several state governments found they could not roll over their debts, forcing them into default. By April 1837, a month after Jackson left the presidency, the great New York diarist Philip Hone noted that “the immense fortunes which we heard so much about in the days of speculation have melted like the snows before an April sun.”

The longest depression in American history had set in. Recovery would not begin until 1843. In Charles Dickens’s A Christmas Carol, published that same year, Ebenezer Scrooge worries that a note payable to him in three days might be as worthless as “a mere United States security.”

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Modern standards preclude government officials and members of Congress from the sort of speculation that was rife in the 1830’s. But today’s affinities between Congressmen and lobbyists, affinities fueled by the largess of political-action committees, have produced many of the same consequences.

Consider the savings-and-loan (S&L) debacle of the 1980’s. The crisis, which erupted only two decades ago but seems all but forgotten, was almost entirely the result of a failure of government to regulate effectively. And that was by design. Members of Congress put the protection of their political friends ahead of the interests of the financial system as a whole.

After the disaster of the Great Depression, three types of banks still survived—artifacts of the Democratic party’s Jacksonian antipathy to powerful banks. Commercial banks offered depositors both checking and savings accounts, and made mostly commercial loans. Savings banks offered only savings accounts and specialized in commercial real-estate loans. Savings-and-loan associations (“thrifts”) also offered only savings accounts; their loan portfolios were almost entirely in mortgages for single-family homes.

All this amounted, in effect, to a federally mandated cartel, coddling those already in the banking business and allowing very few new entrants. Between 1945 and 1965, the number of S&L’s remained nearly constant at about 8,000, even as their assets grew more than tenfold from almost $9 billion to over $110 billion. This had something to do with the fact that the rate of interest paid on savings accounts was set by federal law at .25 percent higher than that paid by commercial banks, in order to compensate for the inability of savings banks and S&L’s to offer checking accounts. Savings banks and S&L’s were often called “3-6-3” institutions because they paid 3 percent on deposits, charged 6 percent on loans, and management hit the golf course at 3:00 p.m. on the dot.

These small banks were very well connected. As Democratic Senator David Pryor of Arkansas once explained:

You got to remember that each community has a savings-and-loan; some have two; some have four, and each of them has seven or eight board members. They own the Chevy dealership and the shoe store. And when we saw these people, we said, gosh, these are the people who are building the homes for people, these are the people who represent a dream that has worked in this country.

They were also, of course, the sorts of people whose support politicians most wanted to have—people who donated campaign money and had significant political influence in their localities.

The banking situation remained stable in the two decades after World War II as the Federal Reserve was able to keep interest rates steady and inflation low. But when Lyndon Johnson tried to fund both guns (the Vietnam war) and butter (the Great Society), the cartel began to break down.

If the government’s first priority had been the integrity of the banking system and the safety of deposits, the weakest banks would have been forced to merge with larger, sounder institutions. Most solvent savings banks and S&L’s would then have been transmuted into commercial banks, which were required to have larger amounts of capital and reserves. And some did transmute themselves on their own. But by 1980 there were still well over 4,500 S&L’s in operation, relics of an earlier time.

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Why was the integrity of the banking system not the first priority? Part of the reason lay in the highly fragmented nature of the federal regulatory bureaucracy. A host of agencies—including the Comptroller of the Currency, the Federal Reserve, the FDIC and the FSLIC, state banking authorities, and the Federal Home Loan Bank Board (FHLBB)—oversaw the various forms of banks. Each of these agencies was more dedicated to protecting its own turf than to protecting the banking system as a whole.

Adding to the turmoil was the inflation that took off in the late 1960’s. When the low interest rates that banks were permitted to pay failed to keep pace with inflation, depositors started to look elsewhere for a higher return. Many turned to money-market funds, which were regulated by the Securities and Exchange Commission rather than by the various banking authorities and were not restricted in the rate of interest they could pay. Money began to flow out of savings accounts and into these new funds, in a process known to banking specialists by the sonorous term “disintermediation.”

By 1980, with inflation roaring above 12 percent—the highest in the country’s peacetime history—the banks were bleeding deposits at a prodigious rate. The commercial banks could cope; their deposit base was mostly in checking accounts, which paid no interest, and their lending portfolios were largely made up of short-term loans whose average interest rates could be quickly adjusted, not long-term mortgages at fixed interest. But to the savings banks and S&L’s, disintermediation was a mortal threat.

Rather than taking the political heat and forcing the consolidation of the banking industry into fewer, stronger, and more diversified banks, Washington rushed to the aid of the ailing S&L’s with quick fixes that virtually guaranteed future disaster. First, Congress eliminated the interest-rate caps. Banks could now pay depositors whatever rates they chose. While it was at it, Congress also raised the amount of insurance on deposits, from $40,000 to $100,000 per depositor.

At the same time, the Federal Home Loan Bank Board changed the rules on brokered deposits. Since the 1960’s, brokers had been making, on behalf of their customers, multiple deposits equal to the limit on insurance. This allowed wealthy customers to possess insured bank deposits of any cumulative size—an end-run around the limit that should never have been tolerated in the first place. Realizing that these deposits were “hot money,” likely to chase the highest return, the Home Loan board forbade banks to have more than five percent of their deposit base in such instruments. But in 1980 it eliminated the restriction.

With no limits on interest rates that could be paid and no risk of loss to the customers, the regulators and Congress had created an economic oxymoron: a high-yield, no-risk security. As money flowed in to take advantage of the situation, the various S&L’s competed among themselves to offer higher and higher interest rates. Meanwhile, however, their loan portfolios were still in long-term home mortgages, many yielding low interest.

As a result, they went broke. In 1980 the S&L’s had a collective net worth slightly over $32 billion. By December 1982 that number had shrunk to less than $4 billion.

To remedy the disaster caused by the quick fixes of 1980, more quick fixes were instituted. The FHLBB lowered reserve requirements—the amount of money that banks must keep in highly liquid form, like Treasury notes, in order to meet any demand for withdrawals—from 5 to 3 percent of deposits. “With the proverbial stroke of the pen,” the journalist L.J. Davis wrote, “sick thrifts were instantly returned to a state of ruddy health, while thrifts that only a moment before had been among the dead who walk were now reclassified as merely enfeebled.”

For good measure, the Bank Board changed its accounting rules, allowing the thrifts to show handsome profits when they were, in fact, going bust. It was a case of regulators authorizing the banks they regulated to cook the books. Far worse, the rule that only locals could own an S&L was eliminated. Now anyone could buy a thrift. High-rollers began to move in, delighted to be able to assume the honorific title of “banker.”

And Congress, ever anxious to help the Chevy dealers and shoe-store owners, lifted the limits on what the thrifts themselves could invest in. No longer were they limited to low-interest, long-term, single-family mortgages. Now they could lend up to 70 percent of their portfolios for commercial real-estate ventures and consumer needs. In short, Congress gave the S&L’s permission to become full-service banks without requiring them to hold the capital and reserves of full-service banks.

Now came the turn of state-chartered thrifts, whose managers understandably wanted to enjoy the same freedoms enjoyed by federally-chartered S&L’s. State governments from Albany to Sacramento were obliging. California, which had the largest number of state-chartered S&L’s, allowed them to invest in anything from junk bonds to start-up software companies—in effect, to become venture-capital firms using government-guaranteed money. The consequence, as predictable as the next solar eclipse, was a collapse of the S&L’s en masse. Between 1985 and 1995, over a thousand were shut down by the government or forced to merge. The cost to the public is estimated to have run $160 billion.

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As the sorry tale of the S&L crisis suggests, the road to financial hell is sometimes paved with good intentions. There was nothing malign in attempting to keep these institutions solvent and profitable; they were of long standing, and it seemed a noble exercise to preserve them. Perhaps even more noble, and with consequences that have already proved much more threatening, was the philosophy that would eventually lead the United States into its latest financial crisis—a crisis that begins, and ends, with mortgages.

A mortgage used to stay on the books of the issuing bank until it was paid off, often twenty or thirty years later. This greatly limited the number of mortgages a bank could initiate. In 1938, as part of the New Deal, the federal government established the Federal National Mortgage Association, nicknamed Fannie Mae, to help provide liquidity to the mortgage market.

Fannie Mae purchased mortgages from initiating banks and either held them in its own portfolio or packaged them as mortgage-backed securities to sell to investors. By taking these mortgages off the books of the issuing banks, Fannie Mae allowed the latter to issue new mortgages. Being a government entity and thus backed by the full faith and credit of the United States, it was able to borrow at substantially lower interest rates, earning the money to finance its operations on the difference between the money it borrowed and the interest earned on the mortgages it held.

Together with the GI Bill of 1944, which guaranteed the mortgages issued to veterans, Fannie Mae proved a great success. The number of Americans owning their own homes climbed steadily, from fewer than 15 percent of non-farm families in the 1930’s to nearly 70 percent by the 1980’s. Thus did Fannie Mae and the GI Bill prove to be powerful engines for increasing the size of the middle class.

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It can be argued that 70 percent is about as high a proportion as could, or should, be hoped for in home ownership. Many young people are not ready to buy a home; many old people prefer to rent. Some families move so frequently that home ownership makes no sense. Some people, like Congressman Charlie Rangel of New York, take advantage of local rent-control laws to obtain housing well below market rates, and therefore have no incentive to buy.

And some families simply lack the creditworthiness needed for a bank to be willing to lend them money, even on the security of real property. Perhaps their credit histories are too erratic; perhaps their incomes and net worth are lower than bank standards; or perhaps they lack the means to make a substantial down payment, which by reducing the amount of the mortgage can protect a bank from a downturn in the real-estate market.

But historically there was also a class, made up mostly of American blacks, for whom home ownership was out of reach. Although simple racial prejudice had long been a factor here, it was, ironically, the New Deal that institutionalized discrimination against blacks seeking mortgages. In 1935 the Federal Housing Administration (FHA), established in 1934 to insure home mortgages, asked the Home Owner’s Loan Corporation—another New Deal agency, this one created to help prevent foreclosures—to draw up maps of residential areas according to the risk of lending in them. Affluent suburbs were outlined in blue, less desirable areas in yellow, and the least desirable in red.

The FHA used the maps to decide whether or not to insure a mortgage, which in turn caused banks to avoid the redlined neighborhoods. These tended to be in the inner city and to comprise largely black populations. As most blacks at this time were unable to buy in white neighborhoods, the effect of redlining was largely to exclude even affluent blacks from the mortgage market.

Even after the end of Jim Crow in the 1960’s, the effect of redlining lingered, perhaps more out of habit than of racial prejudice. In 1977, responding to political pressure to abolish the practice, Congress finally passed the Community Reinvestment Act, requiring banks to offer credit throughout their marketing areas and rating them on their compliance. This effectively outlawed redlining.

Then, in 1995, regulations adopted by the Clinton administration took the Community Reinvestment Act to a new level. Instead of forbidding banks to discriminate against blacks and black neighborhoods, the new regulations positively forced banks to seek out such customers and areas. Without saying so, the revised law established quotas for loans to specific neighborhoods, specific income classes, and specific races. It also encouraged community groups to monitor compliance and allowed them to receive fees for marketing loans to target groups.

But the aggressive pursuit of an end to redlining also required the active participation of Fannie Mae, and thereby hangs a tale. Back in 1968, the Johnson administration had decided to “adjust” the federal books by taking Fannie Mae off the budget and establishing it as a “Government Sponsored Enterprise” (GSE). But while it was theoretically now an independent corporation, Fannie Mae did not have to adhere to the same rules regarding capitalization and oversight that bound most financial institutions. And in 1970 still another GSE was created, the Federal Home Loan Mortgage Corporation, or Freddie Mac, to expand further the secondary market in mortgage-backed securities.

This represented a huge moral hazard. The two institutions were supposedly independent of the government and owned by their stockholders. But it was widely assumed that there was an implicit government guarantee of both Fannie and Freddie’s solvency and of the vast amounts of mortgage-based securities they issued. This assumption was by no means unreasonable. Fannie and Freddie were known to enjoy lower capitalization requirements than other financial institutions and to be held to a much less demanding regulatory regime. If the United States government had no worries about potential failure, why should the market?

Forward again to the Clinton changes in 1995. As part of them, Fannie and Freddie were now permitted to invest up to 40 times their capital in mortgages; banks, by contrast, were limited to only ten times their capital. Put briefly, in order to increase the number of mortgages Fannie and Freddie could underwrite, the federal government allowed them to become grossly undercapitalized—that is, grossly to reduce their one source of insurance against failure. The risk of a mammoth failure was then greatly augmented by the sheer number of mortgages given out in the country.

That was bad enough; then came politics to make it much worse. Fannie and Freddie quickly evolved into two of the largest financial institutions on the planet, with assets and liabilities in the trillions. But unlike other large, profit-seeking financial institutions, they were headquartered in Washington, D.C., and were political to their fingertips. Their management and boards tended to come from the political world, not the business world. And some were corrupt: the management of Fannie Mae manipulated the books in order to trigger executive bonuses worth tens of millions of dollars, and Freddie Mac was found in 2003 to have understated earnings by almost $5 billion.

Both companies, moreover, made generous political contributions, especially to those members of Congress who sat on oversight committees. Their charitable foundations could be counted on to kick in to causes that Congressmen and Senators deemed worthy. Many of the political contributions were illegal: in 2006, Freddie was fined $3.8 million—a record amount—for improper election activity.

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By 2007, Fannie and Freddie owned about half of the $12 trillion in outstanding mortgages, an unprecedented concentration of debt—and of risk. Much of the debt was concentrated in the class of sub-prime mortgages that had proliferated after the 1995 regulations. These were mortgages given to people of questionable credit standing, in one of the attempts by the federal government to increase home ownership among the less well-to-do.

Since banks knew they could offload these sub-prime mortgages to Fannie and Freddie, they had no reason to be careful about issuing them. As for the firms that bought the mortgage-based securities issued by Fannie and Freddie, they thought they could rely on the government’s implicit guarantee. AIG, the world’s largest insurance firm, was happy to insure vast quantities of these securities against default; it must have seemed like insuring against the sun rising in the West.

Wall Street, politicians, and the press all acted as though one of the iron laws of economics, as unrepealable as Newton’s law of universal gravity, had been set aside. That law, simply put, is that potential reward always equals potential risk. In the real world, unfortunately, a high-yield, no-risk investment cannot exist.

In 2006, after an astonishing and unsustainable climb in home values, the inevitable correction set in. By mid-2007, many sub-prime mortgages were backed by real estate that was now of lesser value than the amount of debt. As the market started to doubt the soundness of these mortgages, their value and even their salability began to deteriorate. So did the securities backed by them. Companies that had heavily invested in sub-prime mortgages saw their stock prices and their net worth erode sharply. This caused other companies to avoid lending them money. Credit markets began to tighten sharply as greed in the marketplace was replaced by fear.

A vicious downward spiral ensued. Bear Stearns, the smallest investment bank on Wall Street, was forced into a merger in March with JPMorgan Chase, with guarantees from the Federal Reserve. Fannie and Freddie were taken over by the government in early September; Merrill Lynch sold itself to Bank of America; AIG had to be bailed out by the government to the tune of $85 billion; Lehman Brothers filed for bankruptcy; Washington Mutual became the biggest bank failure in American history and was taken over by JPMorgan Chase; to avoid failure, Wachovia, the sixth largest bank in the country, was taken over by Wells Fargo. The most creditworthy institutions saw interest rates climb to unprecedented levels—even for overnight loans of bank reserves, which are the foundation of the high-functioning capitalist system of the West. Finally it became clear that only a systemic intervention by the government would stem the growing panic and allow credit markets to begin to function normally again.

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Many people, especially liberal politicians, have blamed the disaster on the deregulation of the last 30 years. But they do so in order to avoid the blame’s falling where it should—squarely on their own shoulders. For the same politicians now loudly proclaiming that deregulation caused the problem are the ones who fought tooth and nail to prevent increased regulation of Fannie and Freddie—the source of so much political money, their mother’s milk.

To be sure, there is more than enough blame to go around. Forgetting the lessons of the past, Wall Street acted as though the only direction that markets and prices could move was up. Credit agencies like Moody’s, Standard & Poor’s, and Fitch gave high ratings to securities that, in retrospect, they clearly did not understand. The news media did not even try to investigate the often complex economics behind the housing market.

But remaining at the heart of the financial beast now abroad in the world are Fannie Mae and Freddie Mac and the mortgages they bought and turned into securities. Protected by their political patrons, they were allowed to pile up colossal debt on an inadequate capital base and to escape much of the regulatory oversight and rules to which other financial institutions are subject. Had they been treated as the potential risks to financial stability they were from the beginning, the housing bubble could not have grown so large and the pain that is now accompanying its end would not have hurt so much.

Herbert Hoover famously remarked that “the trouble with capitalism is capitalists. They’re too greedy.” That is true. But another and equal trouble with capitalism is politicians. Like the rest of us, they are made of all-too-human clay and can be easily blinded to reality by naked self-interest, at a cost we are only now beginning to fathom.

Musings on Structural Challenges to the Financial System
Sunday, April 26, 2009
©Naked Capitalism.com

One thing that has me troubled about the financial mess is the degree to which the powers that be are wedded to a system that it clearly broken. In part, that results from financial capture of the government apparatus by the banking industry. But an equally sticky problem is the attachment to a rather recent vision of how the financial system works. And that in turn is oddly reminiscent of destructive patterns in the Great Depression.

If you go back to 1980, the world of finance was very different, The Federal Reserve was considerably larger than any single bank. On balance sheet lending was the norm. Banking was most decidedly not sexy, unless you were Ciitbank, which loved to innovate and push regulatory limits, even though lots of banks then became free riders on its pioneering.

No one in 1980 (outside of MBA programs and certain parts of New York City) knew what an investment banker was. If you used that term with most middle or upper middle class Americans, they would assume it was some sort of glorified stockbroker.

To make a very long story short, securitization changed all that. Banks saw their lunch eaten by investment banks as they were increasingly disintermediated. By 2006, only 15% of the non farm, non-financial credit was via the banking system. What Timothy Geithner called "market based credit" became the norm.

The problem is, as we know, as the model didn't develop as much as devolve. There have been massive information losses. Much of sound banking credit processes has been replaced by sophistry, such as score based credit models that have been demonstrated to perform badly, incomplete loan files (so no one has enough borrower G2 to do updates and triage for mods), a reliance on ratings and hedging in place of credit analysis, even a mortgage registry service that only reduces transparency. And the very worst element is that securiitzation vehicles make debt restructuring, a key element to resolving a financial crisis, well nigh impossible.

And securitization was and remains the epicenter of the crisis. Gillian Tett of the Financial Times tells us:

In Wal-Mart We Trust

Who did the most to help victims of Hurricane Katrina? According to a new study, it was the company everyone loves to hate

Colby Cosh,  National Post 
© 2009 The National Post Company

Shortly before Hurricane Katrina made landfall on the U.S. Gulf Coast on the morning of Aug. 29, 2005, the chief executive officer of Wal-Mart, Lee Scott, gathered his subordinates and ordered a memorandum sent to every single regional and store manager in the imperiled area. His words were not especially exalted, but they ought to be mounted and framed on the wall of every chain retailer -- and remembered as American business's answer to the pre-battle oratory of George S. Patton or Henry V.

"A lot of you are going to have to make decisions above your level," was Scott's message to his people. "Make the best decision that you can with the information that's available to you at the time, and above all, do the right thing."

This extraordinary delegation of authority -- essentially promising unlimited support for the decision-making of employees who were earning, in many cases, less than $100,000 a year -- saved countless lives in the ensuing chaos. The results are recounted in a new paper on the disaster written by Steven Horwitz, an Austrian-school economist at St. Lawrence University in New York. While the Federal Emergency Management Agency fumbled about, doing almost as much to prevent essential supplies from reaching Louisiana and Mississippi as it could to facilitate it, Wal-Mart managers performed feats of heroism. In Kenner, La., an employee crashed a forklift through a warehouse door to get water for a nursing home. A Marrero, La., store served as a barracks for cops whose homes had been submerged. In Waveland, Miss., an assistant manager who could not reach her superiors had a bulldozer driven through the store to retrieve disaster necessities for community use, and broke into a locked pharmacy closet to obtain medicine for the local hospital.

Meanwhile, Wal-Mart trucks pre-loaded with emergency supplies at regional depots were among the first on the scene wherever refugees were being gathered by officialdom. Their main challenge, in many cases, was running a gauntlet of FEMA officials who didn't want to let them through. As the president of the brutalized Jefferson Parish put it in a Sept. 4 Meet the Press interview, speaking at the height of nationwide despair over FEMA's confused response: "If [the U.S.] government would have responded like Wal-Mart has responded, we wouldn't be in this crisis."

This benevolent improvisation contradicts everything we have been taught about Wal-Mart by labour unions and the "small-is-beautiful" left. We are told that the company thinks of its store management as a collection of cheap, brainwash-able replacement parts; that its homogenizing culture makes it incapable of serving local communities; that a sparrow cannot fall in Wal-Mart parking lot without orders from Arkansas; that the chain puts profits over people. The actual view of the company, verifiable from its disaster-response procedures, is that you can't make profits without people living in healthy communities. And it's not alone: As Horwitz points out, other big-box companies such as Home Depot and Lowe's set aside the short-term balance sheet when Katrina hit and acted to save homes and lives, handing out millions of dollars' worth of inventory for free.

No one who is familiar with economic thought since the Second World War will be surprised at this. Scholars such as F. A. von Hayek, James Buchanan and Gordon Tullock have taught us that it is really nothing more than a terminological error to label governments "public" and corporations "private" when it is the latter that often have the strongest incentives to respond to social needs. A company that alienates a community will soon be forced to retreat from it, but the government is always there. Companies must, to survive, create economic value one way or another; government employees can increase their budgets and their personal power by destroying or wasting wealth, and most may do little else. Companies have price signals to guide their productive efforts; governments obfuscate those signals.

Aside from the public vs. private issue, Horwitz suggests, decentralized disaster relief is likely to be more timely and appropriate than the centralized kind, which explains why the U.S. Coast Guard performed so much better during the disaster than FEMA. The Coast Guard, like all marine forces, necessarily leaves a great deal of authority in the hands of individual commanders, and like Wal-Mart, it benefited during and after the hurricane from having plenty of personnel who were familiar with the Gulf Coast geography and economy.

There is no substitute for local knowledge -- an ancient lesson of which Katrina merely provided the latest reminder.

by Jeffrey Goldberg
©The Atlantic
May 2009

For most of our adult lives, my wife and I have behaved in the way responsible cogs of capitalism are supposed to behave—we invested in a carefully calibrated mix of equities and bonds; we bought and held; we didn’t overextend on real estate; we put the maximum in our 401(k) accounts; we gave to charity; and we saved, but we also spent: mainly on gasoline, food, and magazines. In retrospect, we didn’t have the proper appreciation for risk, but who did? We were children of the bull market. Even at its top, my investment portfolio was never anything to write home about. Its saving grace was that it was mine. And I imagined that when we did cash out, at 60 or 65, I would pass my time buying my wife semisubstantial pieces of jewelry and going bass fishing like the men in Flomax commercials.

Well, goodbye to all that. I took a random walk down Wall Street and got hit by a bus.

How am I sure it’s goodbye? The signs are rampant, but one has become stuck in my mind: a video of Richard Bernstein, the chief investment strategist for Merrill Lynch (sorry, I mean the Merrill Lynch division of Bank of America, which, by the time you read this, may be the Bank of America division of the United States Government), advising Merrill clients such as myself that one of the best financial strategies to adopt now would be to extend my “investment time horizon.”

“If one were to trade the S&P 500 for one day, the probability of losing money is about 46 percent,” Bernstein states. “However, as one extends that time horizon from one day to one month to one quarter to one year to 10 years, the probability of losing money decreases as the time horizon lengthens.”

To which I would add this observation from Keynes: “In the long run, we are all dead.”

This is what I heard Bernstein say: give up. You’re not going to make money on your investments in the next 10 years, or 15, or 20, so you should stop worrying about your portfolio and go to the movies like everyone else.

I called Bernstein and asked him if he was, in fact, advocating a form of Stoicism. He said I was misinterpreting his views. “This is not some sort of psychological compensation device. What I’m saying is that in looking for investment ideas, we should be looking over a five-, six-, seven-year time period. You have to give an investment strategy time to reach gestation.”

But my investment strategy gestated for 15 years. And then it died.

As I write this, the markets are back down to 1997 levels. In Japan, they’ve sunk to 1983 levels. I pointed out to Bernstein that 1983 was 26 years ago. The investor who bought Japanese equities in 1983 and held on to them has stayed absolutely flat. “That’s not correct,” Bernstein said. “That doesn’t take into account dividend payments.”

Even with all those munificent dividend payments, my net worth has dropped by a third, and new vistas of worry open up for me each day.

I’m not complaining, by the way, and not only because I have no right to complain. I make more money than most Americans. I will ungrudgingly pay more taxes if it means keeping people in their homes—even the schmucks in overleveraged McMansions. My wife and I are lucky. We have substantial equity in a small but perfectly nice house in Washington, D.C., a city that is now, among other things, America’s financial-services capital, which should help keep real-estate prices steady. I have a late-model minivan. Most important, I have a job (and in the thriving magazine industry, no less!). If I lose my job, then I’ll complain (at which point, of course, I’ll no longer have a public venue for my complaints). But for now, no whining: just confusion and bemusement and fear, along with an uncharacteristic sense of paralysis. In the past six months, I’ve bought and sold virtually no equities. And I rarely take the pulse of my 401(k).

I called a psychologist to find out what could explain this weird passivity. Daniel Kahneman is a Nobel Prize–winning innovator in the field of behavioral economics. He explained that my feelings of paralysis were to be expected.

“You no longer know the world you live in,” he said. “You played by the rules, the rules benefited you. The world functioned according to some regularities. Right now, it’s unclear what rules apply. There is a new regime. What seemed prudent earlier has disappeared. I’m surprised Americans aren’t more panicked. Americans seem to accept a level of insecurity in their lives that Europeans wouldn’t tolerate. Paralysis is one response to this level of insecurity.”

This might explain why my wife and I have taken no action to fix our finances. Although it’s also the case that we haven’t heard from our Merrill broker in nine months. The last time he called was well before the day in September when the government encouraged the shotgun sale of Merrill to Bank of America, to keep Merrill from collapsing.

I should have seen the signs of dysfunction much earlier. It was more than a decade ago that our first Merrill Lynch adviser put us in a company called Boston Chicken. A Merrill analyst described it as “the restaurant concept of the ’90s.” It went bankrupt in 1998. Only later did I learn that Merrill had underwritten the initial public offering for Boston Chicken stock, and so had an interest in selling the company to its customers. There were other brilliant pieces of advice—long-term “buy and hold” recommendations that emerged from the Merrill analysis factory: Qualcomm; Sun Microsystems; Nokia; and Citibank, of course, which has recently dipped as low as a dollar a share. The full-service trading fees at Merrill—$80, $100, $130, for modest chunks of stock—were high, but we were told that we were paying a premium for quality research.

In many cases, we were. Bernstein, the chief strategist, has actually been bearish for much of the past decade. Given his recent disposition toward market pessimism, I asked him why he didn’t tell Merrill’s clients to dump their equities seven months ago. “I said it as best as I could within reasonable professional standards,” he said. “I’m not going to yell ‘Sell, sell, sell!’ I’m not going to go out and be irresponsible.”

I imagine that many of Merrill’s clients are now wishing that Bernstein had been more irresponsible. Of course, even if he had said something, my financial adviser might not have relayed the message.

I haven’t depended solely on Merrill Lynch for advice. I believed I could find investments for myself. I stayed away from mutual funds because I couldn’t figure out who ran them. And I applied Warren Buffett’s famous dictum—Don’t buy something you don’t understand—to my trading, so I bought, in our Merrill Lynch account, such companies as Johnson & Johnson and Procter & Gamble and Illinois Tool Works and Caterpillar, and these have been kind to us, until now. (I also bought the Internet company Ariba, because I heard about it from a guy who heard about it from a guy. It went up to about $1,000; I didn’t sell, of course, and now it’s at $8.) And every so often, I would follow the recommendations of the financial magazines, SmartMoney in particular, because for a long while I was an ardent consumer of financial pornography. No more. In the harsh light of recession, I find it hard to believe I listened to a magazine that, in August 2007, recommended American Express at $63 a share (a “conservative way to make hay from global credit-card growth”), which as I write this is selling for $13 a share; Wynn Resorts, $94 then, $20 now; HSBC, $93 then, $25 now; Washington Mutual, $36 at the time, seized by the government last September—rendering the stock worthless.
It turns out that my crucial mistake was believing that the brokers and wealth managers and cable-television oracles who make up the financial-services industrial complex actually had my best interests at heart. Or so say the extremely smart—and wealthy—people I asked to help me figure a way out of my paralysis. One of these people was Robert Soros, the deputy chairman of the fund started by his father, George. I went to see him at his office, where he spent two hours performing an autopsy on my assumptions.

“You think a brokerage should be a place you go to pay commissions for fair and unbiased advice, right?” he asked.

“Yes,” I said.

“It’s not. It never has been.” He then cited another saying of Buffett’s: “‘Wall Street is a place where whatever can be sold will be sold.’ You are the consumer of their dreck. What they can sell to you, they will sell to you.”

“But they told us—”

“They lied.”

He went on: “You should be disheartened and disappointed. But don’t kid yourself. You’re a naive capitalist. They were never your advisers. Do not for a moment think that a brokerage firm is your friend.”

“So who’s my friend?”

“You don’t have one. This is the market.”

“Okay, that’s Merrill Lynch. What about the others?”

“They’re not your friends,” Soros said patiently.

“What about Chuck Schwab?”

“All brokers move products based on volume and commission,” he said.

I had a benevolent, advertising-induced understanding of Schwab. It was the billboards: “I’ve got a lot less money. And a lot more questions. Talk to Chuck.” And: “It’s not just money. It’s my money. Talk to Chuck.”

I thought that perhaps Schwab, a discount broker, might be able to answer the question Soros could not: Why had my full-service financial adviser stopped calling me?

I did what I was told, and called Chuck. His spokesman intercepted the call. I explained that I was trying to understand the role financial advisers play in the life of the small investor, but the spokesman, Greg Gable, said that Chuck would not, in fact, talk.

“We’re not going to be able to help you out,” he said.

Finally, I went to another highly successful financial adviser, named Larry Gellman, who is an iconoclast and a critic of his industry. He came up with a plausible reason why Merrill did not actually seem to care about my financial future, or the financial future of my children.

“Throughout the late 1990s, investors were firing their brokers and money managers because they didn’t own enough tech and Internet stocks, so everybody got loaded up at the tech party right before the cops came,” Gellman said. “Most of them were busted and never even got a drink. Some of them got lawyers and came after their brokers. So the brokerage firms all came away saying, ‘Never again.’

“If the head of Merrill Lynch and every other investment firm had their way,” he continued, “no individual broker would ever recommend an individual stock or bond to a retail client again. They have essentially gotten out of the brokering-and-advising business and gone all in on the ‘wealth management’ business. The new model is to gather assets from wealthy people and then place those assets with a whole bunch of managers who will manage different pieces of it in diversified styles so you don’t lose it all at once. And by the way, people with less than $10 million need not apply.

“People like you are in a sort of purgatory because no one would ever come out and tell you that he doesn’t want your business anymore,” he said. “You had to figure that out by yourself.”

There’s quite a bit I have to figure out by myself now, which was one reason why, on a cold night in February, I turned up at the apartment of my friend Boaz Weinstein, who was hosting a gathering to talk about charity in a time of financial cataclysm. Weinstein lives in a not-overly-luxurious-but-luxurious-enough building on Fifth Avenue. It is not the sort of building I could ever afford, but I tell myself I am not inclined to live on Fifth Avenue anyway; long-term exposure to liveried elevator operators would eventually bring me to Marxism.

“Do you like this job?” I asked the operator in Weinstein’s building. He was a sagging man of 65 or 70; his eyes were rheumy and his nose spider-webbed with disintegrating capillaries.

“It’s a job,” he said. He paused. “I’m retired.”

“But you’re working,” I said.

“Yeah. I’m working.”

The coatrack in the hallway outside Weinstein’s apartment was crowded with sensible coats. The passed canapés inside were utilitarian, as passed canapés go. These were my kind of rich people, I thought, not the piggy kind, no John Thains or Stephen Schwarzmans in the bunch, certainly no Bernard Madoffs. (I met Madoff once. He wasn’t very nice. I think he judged me too poor to bother robbing.) We had gotten together to talk about charity, but I was hoping to learn about my own economic future. These were people who were calculating present values as 10-year-olds; people who had actual Swiss bank accounts; people who short Treasuries on their BlackBerrys; and one person, Weinstein himself, who won a Maserati in a poker tournament.

The writer Jonathan Rosen has described New York now as having a posthumous feel, but this was not entirely the case in Weinstein’s apartment, which was vibrating with superficial good cheer. Economic disintegration provokes in some people strange feelings of lightness. Of course, some of the people gathered there—say, those who spent the past year short-selling bank stocks—were experiencing the strange feeling of lightness that comes from acquiring huge, stinking piles of money. But on the whole, anxiety lurked beneath the bonhomie. Within 10 minutes of my arrival, two friends separately and quietly suggested I buy gold, and right now.

“You have to guard against the massive debasement of the dollar,” one said. I explained to him my theory of market peaks—that the moment I buy a stock or a commodity is the moment it peaks. In any case, I would need substantially more of those soon-to-be-debased dollars to buy gold. But his arguments seemed sound.

Then another friend approached. “You don’t want to be long gold. The dollar is the currency of last resort for the entire world. There’s little chance of debasement.” His argument also seemed sound. Everyone seemed to be in possession of sound arguments. Even people on CNBC sometimes seem to be in possession of sound arguments.

Weinstein stood up to make introductions. He was one of the early innovators in the field of credit-default swaps, and he earned billions of dollars for his former employer, Deutsche Bank—and tens of millions for himself—until last year, when his trades cost the bank $1.8 billion (though some of the bank’s positions rebounded by $600 million). I am in no position to judge what happened; Weinstein’s attempts to explain to me the workings of credit-default swaps have not borne the fruit of enlightenment.

Bill Ackman, the founder of Pershing Square Capital, was to lead the discussion. Ackman is tall, prematurely gray, and immoderately self-assured, the sort of winning figure who could be elected to the Senate one day, if the country ever decides to stop hating hedge-fund managers. Weinstein introduced Ackman as a perspicacious investor, which he is, generally. Early in the current crisis, he suggested publicly that the decision of the bond-insurance company MBIA to guarantee billions of dollars of complicated mortgage investments would come to no good. But, like Weinstein, Ackman was not having the best year; one of his funds was betting solely on the resurgence of the Target corporation’s stock, and Target’s performance was not covering Ackman in glory.

“I thought this was a perfect time to talk about philanthropy and investing, because they’ve merged; they’re both tax-deductible at this point,” Ackman said, opening his talk. He spoke mainly of the psychic rewards of charitable giving, and of specific projects he supported. He asked for questions, which mainly concerned his prodigious charitable giving. Then someone asked a question about Ackman’s reputation:

“It used to be that in America, if you were a successful businessman, you were well-regarded. Now it seems that you are an evildoer if you’re successful, particularly in the financial world. Your profile is getting bigger. Do you think that’s good, or do people say, ‘He should be spending more time in the office and not so much out there’?”

Ackman responded: “A lot of hedge-fund managers I know are incredibly charitable and also fundamentally great people. But the press—first of all, you don’t make that much money working for the press. Take The New York Times. The New York Times doesn’t make that much money, and the people who work there don’t make that much money. So you think about people who work for the press—generally, they resent people who have financial success. A combination of that, plus some bad actors in the business, is a negative. Why did I go on Charlie Rose? Why have I been a little more public? Part of that is to blunt some of the negative associations with our industry.”

Hmmm. Yes, well.

It only seemed right for me to stick up for my fellow ink-stained proles, so I decided to make an intervention. But then I thought, This is Bill Ackman standing before me. He’s a great investor. Maybe he can give me some advice.

So this is what came out of my mouth: “What do you tell the ordinary mortal—say, the person who works in the press that you talked about—what do you say to the person who has $20,000, $50,000, $100,000, or $200,000, maybe, parked somewhere doing nothing? What is your advice right now for that person?”

I looked around. The wizards in the room were having difficulty calculating figures of such humble size. I had thought $200,000 sounded like a large and unembarrassing number. But the room reacted as if I had asked, “Bill, I have 75 cents in my pocket. Do you think I should buy Twizzlers or a big red gumball?”

Ackman answered: “First, it depends on when you’re going to need the money. I’ve always said that if you want to take risk—any risk—you have to be prepared to put your money away for five years or more. If it’s that kind of money, I would give someone a couple of alternatives. Do you have enough money in the bank that if you were to lose your job, you’ve got a good window to get reemployed? You’ve got to make sure you have a safety net. Buy a house. I think it’s a great time to buy a house. But put a 20 percent down payment, get a good mortgage from Fannie and Freddie … It’s one of the best investments you could make. The rest of the money, either invest in a very broad index fund—a Wilshire 5000 type of index fund—or if you want to do a bit of homework, I’d invest in a few great unlevered businesses that earn attractive returns. In my opinion, McDonald’s, Visa, maybe Berkshire Hathaway.”

I think Ackman might not have been accustomed to talking to people like me, which would help explain why he sounded suspiciously like … a Merrill Lynch financial adviser.

He was, however, infinitely more compelling on the macro questions, and this was where the evening took a dark turn. “One of the things that’s interesting about the last year is that you realize how much of our capital system is based on confidence—business confidence,” he said. “If I’m confident I can refinance my debts when they come due, I’ll spend money. If I’m not confident I can refinance my debts when they come due, I’m not spending any more money. So if I can’t renew my home-equity loan and I’m not sure I can keep my job, I can’t spend. And you get into this death spiral.”

I asked him, “What’s the chance we’re going into that death spiral?”

“We’re in it!” he said. “Whether we’re going to die or not is another question.”

“What’s the percentage chance we’re going to move to a barter economy?” I asked.

“I think it’s small,” Ackman said.

“Small”? I had been hoping for “Zero.” “Zero” would have been a fine answer, and not because I have nothing to barter except for a stack of old SmartMoney magazines, but “Zero” because, by the time my 12-year-old turns 18, I would like to be able to use my portfolio of stocks and bonds as a flotation device, and not as kindling.
THE WAY I SEE IT, it’s all a con game,” Cody Lundin was saying. “What I mean is that Wall Street has always been an illusion. Now it’s an illusion that’s crumbling. Wall Street is like someone who’s having heart trouble. It’s in constant need of resuscitation, but after a while, it just doesn’t work anymore. People think that Bernard Madoff was unique, that he was an illusion, but he’s just an extension of the same illusion, the same con game. This is one of the reasons I don’t like to have any debt. When you have debt, you become part of this illusion, and sometimes you get trapped by it.”

We were standing outside in a foot of snow in the mountains above Prescott, Arizona. Lundin was arguing so cogently against the American culture of easy credit, in tones far more thoughtful than one hears on cable television, that I forgot for a moment that he wasn’t wearing shoes, or socks. He was standing in the snow barefoot. Also, in shorts.

“It’s all about regulating core body temperature.” For long hikes in the snow, he wears three pairs of socks, without shoes. He suggested I try this.

Other things Lundin asked me to try include making fire with sticks, eating mice—“a free source of protein in survival scenarios”—and living without electricity for a week to “see where it hurts.” Lundin himself eats mice and rats he traps at his off-the-grid passive-solar house in the wilderness, because “why waste free protein?”

Lundin is a freak; twin blond braids fall from his bandanna-covered head, giving him the appearance of a stoner Viking. But in the event that the economy crumbles, and civilization with it, I would appoint him my financial adviser. He is my favorite survivalist, the author of a book on getting by in the wilderness and another on urban preparedness, and a teacher of primitive-living skills. Survivalist, of course, has ugly political connotations. A long time ago, I visited a place called Elohim City, on the Oklahoma-Arkansas border, that was home to a group of white supremacists. Their racism was repulsive, and their anti-Semitism wasn’t too pleasant, either. But I was impressed with one aspect of their lifestyle. On a tour, they showed me a vast storeroom filled with beans. Pinto beans, lima beans, all sorts of beans, vacuum-packed in garbage-can-size vats. Three years of food, for when the revolution comes. I knew, of course, that I didn’t need three years of beans in my house, but I took the lesson: it’s not the worst thing in the world to have a couple of weeks of food and water on hand, just in case a natural or man-made emergency is more than FEMA can handle.

Lundin is not a racist; in fact, he’s an Obama supporter, and he resents the racist associations attached to survivalism. Nor does he wish for the grid to go down. He says he enjoys electricity and indoor plumbing. He tends to think, though, that civilization is a thin film, and that in times of economic distress, it’s smart to be prepared for the day when Safeway runs out of milk. “This isn’t something I hope for. But what if the illusion does really crumble, and we have to move as a society to something else?”

I asked Cody how he invests his money. “I don’t believe in the intangible economy; I believe in the tangible economy. When I have extra money, I buy tools, food, or land. I like to be able to see what I’m buying. And I really don’t like debt, so I’d rather not have certain things than be in debt to anyone. I just feel better knowing that I don’t owe money, and I feel good knowing that I can take care of myself. That’s the American way, to be able to be self-reliant.”

For the record, I don’t think the grid is buckling under the weight of consumer debt or the mistakes of AIG. But we’re in a strange moment in American history when a mouse-eating barefoot survivalist in the mountains of Arizona makes more sense than the chief investment strategist of Merrill Lynch.

“People need a plan, they need skills, and they need supplies. What would happen if the ATMs stopped working for a couple of days? People would panic. But you won’t panic if you’re prepared to ride out a disturbance.”

Even out West, he says, people in the cities are unequipped to go for more than a day or two on their own. The Mormons, who are strongly encouraged by their church to keep a year’s supply of food in their homes, are an exception. “I know some people who say that if things go to hell, they’re just going to go to some Mormon’s house and steal all his shit. But that’s not right.”

“Also, many Mormons keep guns.”

“Yeah, there’s that.”

The curious thing about listening to Cody Lundin is that in his ideas I heard echoes of ideas I’ve been hearing from people very much dependent on the financial grid. Bill Gross, the founder of Pimco, the world’s leading bond trader (and, according to a September 2008 ranking by Forbes, America’s 227th-richest person), suggested that thrift—not mouse-eating thrift, but more moderate forms of thrift—is quickly becoming the norm, as a result of society’s massive over-leveraging.

“Risk-taking went over the edge,” he told me. “We are inventing something new. We’re very afraid. We know from the Depression that people who lived through it didn’t change their mentality for the rest of their lives. They were sewing their socks. They refused to take a lot of chances. My sense is that it will take 10 or 20 years to find that spark of risk-taking in people again.”

When I told Seth Klarman, one of the country’s leading value investors, about my visit with Cody Lundin, he said, “It’s always smart to prepare for disaster. In investing, that means holding disaster insurance. In your personal life, it makes sense to have inexpensive disaster protection, so come what may, you’re ready for any eventuality. I like to store some extra bottled water in the basement, but my wife thinks it’s too much clutter. I told her I’d share my water with her anyway.”

While I’d choose Cody Lundin to serve as my off-the-grid adviser, I would choose Seth Klarman as my on-the-grid adviser, if only he were taking clients.

Klarman was hired out of Harvard Business School to manage a $27 million fund that, as of early this year, had grown to $14 billion. He is also the author of one of the more expensive books in the world, Margin of Safety. An out-of-print guide to value investing, it sells for as much as $2,500 per copy on the Web.

Klarman is an acolyte of Ben Graham, the original value investor. Value investors—Warren Buffett is the most famous—seek out distressed, underappreciated assets, buy them, and wait until the rest of the world realizes that they’re worth something.

“The overwhelming majority of people are comfortable with consensus, but successful investors tend to have a contrarian bent,” Klarman said over lunch one day in an empty Boston restaurant. “Successful investors like stocks better when they’re going down. When you go to a department store or a supermarket, you like to buy merchandise on sale, but it doesn’t work that way in the stock market. In the stock market, people panic when stocks are going down, so they like them less when they should like them more. When prices go down, you shouldn’t panic, but it’s hard to control your emotions when you’re overextended, when you see your net worth drop in half and you worry that you won’t have enough money to pay for your kids’ college.”

One theme of Margin of Safety is that people like me aren’t equipped to be investors. “No one knows what he’s doing unless he’s a full-time professional,” he said. “As in many professions, full-time experts have an enormous advantage. Investing is highly sophisticated and nuanced. The average person would have an incredibly hard time competing.”

I asked Klarman if he wasn’t working against his own financial interest by arguing that average people aren’t qualified to be investors.

“Most people on Wall Street do well enough,” he said. “It’s regrettable that anyone would want a client to take risks beyond what the client could handle.”

He agreed with Robert Soros that the financial-services industry treats the small investor not as a client but as a source of ready cash. “The average person can’t really trust anybody. They can’t trust a broker, because the broker is interested in churning commissions. They can’t trust a mutual fund, because the mutual fund is interested in gathering a lot of assets and keeping them. And now it’s even worse because even the most sophisticated people have no idea what’s going on.”

After 15 years of pabulum, I was enjoying, in a perverse sort of way, receiving straight talk from masters of finance.

“Everybody these days is a just-in-time investor. People say, ‘I’m going to leave my money in the market as long as possible, and then pull it out of the market just before I have to write the tuition check.’ But I think we’re seeing that the day you need to pull it out of the market, the market might be down 50 percent. It’s critical not to be greedy. Avoid leverage and don’t invest money that you can’t stand to lose.”

“I haven’t leveraged myself,” I said.

He asked me if I had a mortgage. Yes. He then asked me if the amount of money I had invested in the stock market was greater than the amount I owed on my mortgage—could I liquidate what remained of my portfolio to pay off my mortgage? I could.

“So you are leveraged. Why are you keeping your money in the market?”

“Because—”

“It’s because you think you’re going to make more money in the market than you’re paying in interest on your mortgage.”

“Yup.”

“Well, are you?”

“Uhh, no. But I’m getting the mortgage-interest deduction.”

“Yes, the interest is deductible. But if you had capital gains in the market, you’d pay taxes on those. In the aftermath of this financial crisis, I think everyone needs to look deep within themselves and ask how they want to live their lives. Do they want to live close to the edge, or do they want stability? In my view, people should have a year or two of living expenses in cash if possible, and they shouldn’t use leverage anywhere in their lives.”

“But if I dump my portfolio now, I make my losses real.”

“How are you going to feel if the market drops another 50 percent?”

Klarman went on, “Here’s how to know if you have the makeup to be an investor. How would you handle the following situation? Let’s say you own a Procter & Gamble in your portfolio and the stock price goes down by half. Do you like it better? If it falls in half, do you reinvest dividends? Do you take cash out of savings to buy more? If you have the confidence to do that, then you’re an investor. If you don’t, you’re not an investor, you’re a speculator, and you shouldn’t be in the stock market in the first place.”

Several years ago, I went to a party at a hedge-fund manager’s loft in Lower Manhattan. The elevator opened directly into the loft, which was as big as Mussolini’s office. An Austin Powers bed was parked to one side.

I left the party with a friend of mine, David Segal, who is now a business reporter at The New York Times. As we walked to the subway, he said, “You know, we should get one of those hedge funds.”

“Absolutely,” I said. “Where do we get one?”

“I don’t know. Maybe we can find one on the street. But we need one.”

“Yes, we do.”

When I think back on that conversation, I realize that it represents for me the apex of hedge-fund mania. Which is to say, when two reporters realize they should get into the hedge-fund business, it might be somewhat late to get into the hedge-fund business.

Seth Klarman is right. I’m not an investor. Very few people in America actually are. I never had the knowledge or the time to master the stock market. I thought I knew how to manage the danger, which is why I invested to a disproportionate degree in the Dow 30. I’ve learned, however, that it’s quite possible to ride the Dow 30 a far way along the risk curve. And I’ve learned another thing: I once believed that a buy-and-hold strategy would make me rich. This was a mistaken belief. “The economy comes in cycles,” Robert Soros said. “If you believe that the economy is not cyclical, then buy-and-hold is for you.” He taught me a Wall Street expression: “An investment is a trade gone bad.”

Though the past six months of my financial life have been marked mainly by paralysis, I have, in fact, made a couple of decisions. I’ve decided to deplete the world’s supply of gold by two ounces. (Attention all Atlantic-reading burglars: it’s not in my house.) You’ll be pleased to know that the price of gold fell $70 the week after I bought.

And my wife and I have decided to fire our Merrill Lynch financial adviser. We’re not firing him because we realized that his company couldn’t manage its own money, much less ours, and we’re not firing him for his bad advice. I was the one, after all, who pulled the trigger on the purchase of 100 shares of AIG. (It would have been good of him to warn us about what was coming, but that would have necessitated him knowing what was coming.) We’re also not firing him because his research chief wants us to elongate our already too-long time horizon. And we’re not firing him because John Thain, his former CEO, spent the fees we paid his company on a $35,000 commode. We’re firing him mainly because he fired us. He never said he was firing us. He just stopped calling. Eventually, I stopped calling him. I got the message.

Our main job now is finding someone to advise us. This is a very difficult task.

I asked Bill Gross what he thought I should do. He was somewhat dyspeptic. “The system is rigged,” he said. “It’s difficult for the average investor to even conceptualize what we’re talking about. For this reason, I think financial advisers are still worthwhile, but the average investor can no longer pay them what they felt they were worth. You should find someone who isn’t overpromising or overcharging.”

This search is made more difficult because we don’t have enough money to make ourselves interesting to most of the best advisers, and the typical adviser is not sufficiently independent-minded to be effective.

“There’s enormous pressure to provide conventional advice,” Klarman explained, “and tremendous pressure against providing unconventional advice. Advisers only recommend what’s conventionally palatable. They tend to say 60 percent stocks, 40 percent bonds, and they’re not likely to move away from that, no matter how extreme valuations are. They’re not likely to move away from it when the market is really high, or really low. A big part of the problem is that there isn’t a perfect answer to any of this. No one can tell you how to allocate your assets 100 percent of the time. The average investor is not getting Warren Buffett to look at his portfolio; he’s getting a printout from a computer model.”

Unconventionality makes me nervous, but less so than conformity. I’m finished with conformity. In picking an adviser, I’m also looking for someone who is unleveraged; someone who is putting his own money into the investments he’s recommending; and someone who can explain to me in a few sentences, in language easily understood by earthlings, his philosophy of investing.

Despite everything, I’m not overly pessimistic. I’m long on America, as my friends on Wall Street might say. I believe that equities will grow in value. I expect the Dow to return to 9,000, or 10,000, if not sooner, then later. And when it does, if I’m not already out, I might just get out. I’m not enjoying this particular ride.

I no longer expect to get rich. It makes me happy to realize this. It also makes it easier to give more money to charity. In retrospect, I can’t imagine what led all of us to believe that we could regularly expect double-digit annual returns on our money, for doing no work. Maybe this attitude will cause me to miss the next great run-up. No matter. I’ll take 3 or 4 percent gains a year, or 1 or 2, if necessary. I’ll keep more cash on hand. I’ll keep a two-week supply of meals-ready-to-eat, bottled water, and lanterns in my basement. If things get bad, I’ll take my family and drive west, to find Cody Lundin. And if the bottom truly falls out, I’ll find a Mormon and ask him, politely, if he’ll share.

Iraq moved away from religious sectarianism toward more secular nationalism. "All the parties that had the words 'Islamic' or 'Arab' in their names lost," noted Middle East expert Amir Taheri. "By contrast, all those that had the words 'Iraq' or 'Iraqi' gained."

Prime Minister Nouri al-Maliki went from leader of a small Islamic party to leader of the "State of Law Party," campaigning on security and secular nationalism. He won a smashing victory. His chief rival, a more sectarian and pro-Iranian Shiite religious party, was devastated. Another major Islamic party, the pro-Iranian Sadr faction, went from 11 percent of the vote to 3 percent, losing badly in its stronghold of Baghdad. The Islamic Fadhila party that had dominated Basra was almost wiped out.

The once-dominant Sunni party affiliated with the Muslim Brotherhood and the erstwhile insurgency was badly set back. New grass-roots tribal ("Awakening") and secular Sunni leaders emerged.

All this barely pierced the consciousness of official Washington. After all, it fundamentally contradicts the general establishment/media narrative of Iraq as "fiasco."

One leading conservative thinker had concluded as early as 2004 that democracy in Iraq was "a childish fantasy." Another sneered that the 2005 election that brought Maliki to power was "not an election but a census" -- meaning people voted robotically according to their ethnicity and religious identity. The implication being that these primitives have no conception of democracy, and that trying to build one there is a fool's errand.
What was lacking in all this condescension is what the critics so pride themselves in having -- namely, context. What did they expect in the first elections after 30 years of totalitarian rule that destroyed civil society and systematically annihilated any independent or indigenous leadership? The only communal or social ties remaining after Saddam Hussein were those of ethnicity and sect.
But in the intervening years, while the critics washed their hands of Iraq, it began developing the sinews of civil society: a vibrant free press, a plethora of parties, the habits of negotiation and coalition-building. Reflecting these new realities, Grand Ayatollah Ali Sistani this time purposely and publicly backed no party, strongly signaling a return -- contra Iran -- to the Iraqi tradition of secular governance.
The big strategic winner here is the United States. The big loser is Iran. The parties Tehran backed are in retreat. The prime minister who staked his career on a strategic cooperation agreement with the United States emerged victorious. Moreover, this realignment from enemy state to emerging democratic ally, unlike Egypt's flip from Soviet to U.S. ally in the 1970s, is not the work of a single autocrat (like Anwar Sadat), but a reflection of national opinion expressed in a democratic election.

This is not to say that these astonishing gains are irreversible. There loom three possible threats: (a) a coup from a rising and relatively clean military disgusted with the corruption of civilian politicians -- the familiar post-colonial pattern of the past half-century; (b) a strongman emerging from a democratic system (Maliki?) and then subverting it, following the Russian and Venezuelan models; or (c) the collapse of the current system because of a premature U.S. withdrawal that leads to a collapse of security.
Averting the first two is the job of Iraqis. Averting the third is the job of the United States. Which is why President Obama's reaction to these remarkable elections, a perfunctory statement noting that they "should continue the process of Iraqis taking responsibility for their future," was shockingly detached and ungenerous.

When you become president of the United States you inherit its history, even the parts you would have done differently. Obama might argue that American sacrifices in Iraq were not worth what we achieved. But for the purposes of current and future policy, that is entirely moot. Despite Obama's opposition, America went on to create a small miracle in the heart of the Arab Middle East. President Obama is now the custodian of that miracle. It is his duty as leader of the nation that gave birth to this fledgling democracy to ensure that he does nothing to undermine it.

©USCG Commanders Journal Online
Sunday, December 7, 2008

How Modern Law Makes Us Powerless:  The real barrier to Barack Obama's 'responsibility' era
By PHILIP K. HOWARD

©The Wall Street Journal
JANUARY 26, 2009

Calling for a "new era of responsibility" in his inaugural address, President Barack Obama reminded us that there are no limits to "what free men and women can achieve." Indeed. America achieved greatness as the can-do society. This is, after all, the country of Thomas Paine and barn raisings, of Grange halls and Google. Other countries shared, at least in part, our political freedoms, but America had something different -- a belief in the power of each individual. President Obama's clarion call of self-determination -- "Yes We Can" -- hearkens back to the core of our culture.

But there's a threshold problem for our new president. Americans don't feel free to reach inside themselves and make a difference. The growth of litigation and regulation has injected a paralyzing uncertainty into everyday choices. All around us are warnings and legal risks. The modern credo is not "Yes We Can" but "No You Can't." Our sense of powerlessness is pervasive. Those who deal with the public are the most discouraged. Most doctors say they wouldn't advise their children to go into medicine. Government service is seen as a bureaucratic morass, not a noble calling. Make a difference? You can't even show basic human kindness for fear of legal action. Teachers across America are instructed never to put an arm around a crying child.

The idea of freedom as personal power got pushed aside in recent decades by a new idea of freedom -- where the focus is on the rights of whoever might disagree. Daily life in America has been transformed. Ordinary choices -- by teachers, doctors, officials, managers, even volunteers -- are paralyzed by legal self-consciousness. Did you check the rules? Who will be responsible if there's an accident? A pediatrician in North Carolina noted that "I don't deal with patients the same way any more. You wouldn't want to say something off the cuff that might be used against you."

Here we stand, facing the worst economy since the Great Depression, and Americans no longer feel free to do anything about it. We have lost the idea, at every level of social life, that people can grab hold of a problem and fix it. Defensiveness has swept across the country like a cold wave. We have become a culture of rule followers, trained to frame every solution in terms of existing law or possible legal risk. The person of responsibility is replaced by the person of caution. When in doubt, don't.

All this law, we're told, is just the price of making sure society is in working order. But society is not working. Disorder disrupts learning all day long in many public schools -- the result in part, studies by NYU Professor Richard Arum found, of the rise of student rights. Health care is like a nervous breakdown in slow motion. Costs are out of control, yet the incentive for doctors is to order whatever tests the insurance will pay for. Taking risks is no longer the badge of courage, but reason enough to get sued. There's an epidemic of child obesity, but kids aren't allowed to take the normal risks of childhood. Broward County, Fla., has even banned running at recess.

The flaw, and the cure, lie in our conception of freedom. We think of freedom as political freedom. We're certainly free to live and work where we want, and to pull the lever in the ballot box. But freedom should also include the power of personal conviction and the authority to use your common sense. Analyzing the American character, Alexis de Tocqueville, considered "freedom less necessary in great things than in little ones. . . . Subjection in minor affairs does not drive men to resistance, but it crosses them at every turn, till they are led to sacrifice their own will. Thus their spirit is gradually broken and their character enervated."

This is not an ideological point. Freedom in daily choices is essential for practical reasons -- necessary for government officials and judges as well as for teachers, doctors and entrepreneurs. The new legal order doesn't honor the individuality of human accomplishment. People accomplish things by focusing on the goal, and letting their instincts, mainly subconscious, try to get them there. "Amazingly few people," management guru Peter Drucker observed, "know how they get things done." Most things happen, the philosopher Michael Polanyi wrote, through "the usual process of trial and error by which we feel our way to success." Thomas Edison put it this way: "Nothing that's any good works by itself. You got to make the damn thing work."

Modern law pulls the rug out from under all those human powers and substitutes instead a debilitating self-consciousness. Teachers lose their authority, Prof. Arum found, because the overhang of law causes "hesitation, doubt and weakening of conviction." Skyrocketing health-care costs are impossible to contain as long as doctors go through the day thinking about how they will defend themselves if a sick person sues.

The overlay of law on daily choices destroys the human instinct needed to get things done. Bureaucracy can't teach. Rules don't make things happen. Accomplishment is personal. Anyone who has felt the pride of a job well done knows this.

How do we restore Americans' freedom in daily choices? Freedom is notoriously malleable towards self-interest. "We all declare for liberty," Abraham Lincoln observed, "but in using the same word we do not all mean the same thing."

Freedom, however, is not just a shoving match. Freedom has a formal structure. It has two components:

1) Law sets boundaries that proscribe what we must do or can't do -- you must not steal, you must pay taxes.

2) Those same legal boundaries protect an open field of free choice in all other matters.

The forgotten idea is the second component -- that law must affirmatively define an area free from legal interference. Law must provide "frontiers, not artificially drawn," as philosopher Isaiah Berlin put it, "within which men should be inviolable."

This idea has been lost to our age. When advancing the cause of freedom, law today is all proscription and no protection. There are no boundaries, just a moving mudbank comprised of accumulating bureaucracy and whatever claims people unilaterally choose to assert. People wade through law all day long. Any disagreement in the workplace, any accident, any incidental touching of a child, any sick person who gets sicker, any bad grade in school -- you name it. Law has poured into daily life.

The solution is not just to start paring back all the law -- that would take 10 lifetimes, like trying to prune the jungle. We need to abandon the idea that freedom is a legal maze, where each daily choice is like picking the right answer on a multiple-choice test. We need to set a new goal for law -- to define an open area of free choice. This requires judges and legislatures to affirmatively assert social norms of what's reasonable and what's not. "The first requirement of a sound body of law," Justice Oliver Wendell Holmes Jr. wrote, "is that it should correspond with the actual feelings and demands of the community."

The profile of authority structures needed to defend daily freedoms is not hard to imagine. Judges would aspire to keep lawsuits reasonable, understanding that what people sue for ends up defining the boundaries of free interaction. Schools would be run by the instincts and values of the humans in charge -- not by bureaucratic micromanagement -- and be held accountable for how they do. Government officials would have flexibility to meet public goals, also with accountability. Public choices would aspire to balance for the common good, not, generally, to appease someone's rights.

Reviving the can-do spirit that made America great requires a legal overhaul of historic dimension. We must scrape away decades of accumulated legal sediment and replace it with coherent legal goals and authority mechanisms, designed to affirmatively protect individual freedom in daily choices. "A little rebellion now and then is a good thing," Thomas Jefferson wrote to James Madison, "and as necessary in the political world as storms are in the physical . . . ." The goal is not to change our public goals. The goal is make it possible for free citizens to achieve them.

On the day the Colombian military freed Ingrid Betancourt and 14 other long-held hostages, the Italian Parliament passed yet another resolution demanding her release. Europe had long ago adopted this French-Colombian politician as a cause celebre. France had made her an honorary citizen of Paris, passed numerous resolutions and held many vigils.

For Most People, College Is a Waste of Time
©The Wall Street Journal
AUGUST 13, 2008
By CHARLES MURRAY

Imagine that America had no system of post-secondary education, and you were a member of a task force assigned to create one from scratch. One of your colleagues submits this proposal:

First, we will set up a single goal to represent educational success, which will take four years to achieve no matter what is being taught. We will attach an economic reward to it that seldom has anything to do with what has been learned. We will urge large numbers of people who do not possess adequate ability to try to achieve the goal, wait until they have spent a lot of time and money, and then deny it to them. We will stigmatize everyone who doesn't meet the goal. We will call the goal a "BA."

You would conclude that your colleague was cruel, not to say insane. But that's the system we have in place.

Finding a better way should be easy. The BA acquired its current inflated status by accident. Advanced skills for people with brains really did get more valuable over the course of the 20th century, but the acquisition of those skills got conflated with the existing system of colleges, which had evolved the BA for completely different purposes.

Outside a handful of majors -- engineering and some of the sciences -- a bachelor's degree tells an employer nothing except that the applicant has a certain amount of intellectual ability and perseverance. Even a degree in a vocational major like business administration can mean anything from a solid base of knowledge to four years of barely remembered gut courses.

The solution is not better degrees, but no degrees. Young people entering the job market should have a known, trusted measure of their qualifications they can carry into job interviews. That measure should express what they know, not where they learned it or how long it took them. They need a certification, not a degree.

The model is the CPA exam that qualifies certified public accountants. The same test is used nationwide. It is thorough -- four sections, timed, totaling 14 hours. A passing score indicates authentic competence (the pass rate is below 50%). Actual scores are reported in addition to pass/fail, so that employers can assess where the applicant falls in the distribution of accounting competence. You may have learned accounting at an anonymous online university, but your CPA score gives you a way to show employers you're a stronger applicant than someone from an Ivy League school.

The merits of a CPA-like certification exam apply to any college major for which the BA is now used as a job qualification. To name just some of them: criminal justice, social work, public administration and the many separate majors under the headings of business, computer science and education. Such majors accounted for almost two-thirds of the bachelor's degrees conferred in 2005. For that matter, certification tests can be used for purely academic disciplines. Why not present graduate schools with certifications in microbiology or economics -- and who cares if the applicants passed the exam after studying in the local public library?

Certification tests need not undermine the incentives to get a traditional liberal-arts education. If professional and graduate schools want students who have acquired one, all they need do is require certification scores in the appropriate disciplines. Students facing such requirements are likely to get a much better liberal education than even our most elite schools require now.

Certification tests will not get rid of the problems associated with differences in intellectual ability: People with high intellectual ability will still have an edge. Graduates of prestigious colleges will still, on average, have higher certification scores than people who have taken online courses -- just because prestigious colleges attract intellectually talented applicants.

But that's irrelevant to the larger issue. Under a certification system, four years is not required, residence is not required, expensive tuitions are not required, and a degree is not required. Equal educational opportunity means, among other things, creating a society in which it's what you know that makes the difference. Substituting certifications for degrees would be a big step in that direction.

The incentives are right. Certification tests would provide all employers with valuable, trustworthy information about job applicants. They would benefit young people who cannot or do not want to attend a traditional four-year college. They would be welcomed by the growing post-secondary online educational industry, which cannot offer the halo effect of a BA from a traditional college, but can realistically promise their students good training for a certification test -- as good as they are likely to get at a traditional college, for a lot less money and in a lot less time.

Certification tests would disadvantage just one set of people: Students who have gotten into well-known traditional schools, but who are coasting through their years in college and would score poorly on a certification test. Disadvantaging them is an outcome devoutly to be wished.

No technical barriers stand in the way of evolving toward a system where certification tests would replace the BA. Hundreds of certification tests already exist, for everything from building code inspectors to advanced medical specialties. The problem is a shortage of tests that are nationally accepted, like the CPA exam.

But when so many of the players would benefit, a market opportunity exists. If a high-profile testing company such as the Educational Testing Service were to reach a strategic decision to create definitive certification tests, it could coordinate with major employers, professional groups and nontraditional universities to make its tests the gold standard. A handful of key decisions could produce a tipping effect. Imagine if Microsoft announced it would henceforth require scores on a certain battery of certification tests from all of its programming applicants. Scores on that battery would acquire instant credibility for programming job applicants throughout the industry.

An educational world based on certification tests would be a better place in many ways, but the overarching benefit is that the line between college and noncollege competencies would be blurred. Hardly any jobs would still have the BA as a requirement for a shot at being hired. Opportunities would be wider and fairer, and the stigma of not having a BA would diminish.

Most important in an increasingly class-riven America: The demonstration of competency in business administration or European history would, appropriately, take on similarities to the demonstration of competency in cooking or welding. Our obsession with the BA has created a two-tiered entry to adulthood, anointing some for admission to the club and labeling the rest as second-best.

Here's the reality: Everyone in every occupation starts as an apprentice. Those who are good enough become journeymen. The best become master craftsmen. This is as true of business executives and history professors as of chefs and welders. Getting rid of the BA and replacing it with evidence of competence -- treating post-secondary education as apprenticeships for everyone -- is one way to help us to recognize that common bond.

Mr. Murray is the W.H. Brady Scholar at the American Enterprise Institute. This essay is adapted from his forthcoming book, "Real Education: Four Simple Truths for Bringing America's Schools Back to Reality" (Crown Forum).

“There is nothing the busy man is less busied with than living; there is nothing harder to learn.”
-Seneca

Few of us would consider ourselves philosophers.

Most of us can recall at least one turtleneck-wearing intellectual in college who dedicated countless hours of study to the most obscure philosophical points of Marx or post-structural lesbian feminism. For what? Too often, to posture as a superior intellect at meal time or over drinks.

Fortunately, there are a few philosophical systems designed to produce dramatic real-world effects without the nonsense. Unfortunately, they get punished because they lack the ambiguity required for weeks of lectures and expensive textbooks.

In the last three years, I’ve begun to explore one philosophical system in particular: Stoicism. Though my preferred Stoic writer, Lucius Seneca, I’ve found it to be a simple and immensely practical set of rules for better results with less effort.

Ryan Holiday is 21 years old and works directly with Dov Charney as his online strategist for American Apparel. He gets more heat, makes more high-stakes decisions, and take more risks in a given week than most people experience in any given quarter. He also happens to be a die-hard Stoic and incredible at putting the principles into practice…

He kindly agreed to write this piece, and I hope you find it as valuable as I do.

Stoicism 101: A Beginner’s Guide for Entrepreneurs

Author: Ryan Holiday

For those of us who live our lives in the real world, there is one branch of philosophy created just for us: Stoicism.

It doesn’t concern itself with complicated theories about the world, but with helping us overcome destructive emotions and act on what can be acted upon. Just like an entrepreneur, it’s built for action, not endless debate. 

When laid out in front of you, it should be instantly clear what it means. If you have to study it to understand it, someone is probably try to pull something over on you.

Popular with the educated elite of the Greco-Roman Empire, and with thinkers like Montaigne, John Stuart Mill and Tom Wolfe, Stoicism has just a few central teachings. It sets out to remind us of how unpredictable the world can be. How brief our moment of life is. How to be steadfast, and strong, and in control of yourself. And finally, that the source of our dissatisfaction lies in our impulsive dependency on our reflexive senses rather than logic.

If this were your average introduction to philosophy, we would have to talk about how Stoicism was started (stoa means porch, where the early followers used to hold meetings) and when it began. I happen to think that the history of a philosophy is less interesting than its proponents and applications. So, for a change, let’s spend our time on the latter.

Stoicism had three principle leaders. Marcus Aurelius, the emperor of the Roman Empire, the most powerful man on earth, sat down each day to write himself notes about restraint, compassion and humility. Epictetus endured the horrors of slavery to found his own School where he taught many of Rome’s greatest minds. Seneca, when Nero turned on him and demanded his suicide, could think only of comforting his wife and friends. 

Stoicism differs from most existing schools in one important sense: its purpose is practical application. It is not an intellectual enterprise. It’s a tool that we can use to become better entrepreneurs, better friends and better people.

Stoic writing isn’t about beating up on yourself or pointing out the negative. It’s a meditative technique that transforms negative emotions into a sense of calm and perspective.

It’s easy to gloss over the fact that Marcus Aurelius was the Roman Emperor without truly absorbing the gravity of that position. Emperors were Dieties, ordinary men with direct access to unlimited wealth and adulation. Before you jump to the conclusion that the Stoics were dour and sad men, ask yourself, if you were a dictator, what would your diary look like? How quickly could it start to resemble Kayne West’s blog?

Stoic writing is much closer Yoga session or a pre-game warm up than to a book of philosophy a university professor might write. It’s preparation for the philosophic life - an action - where the right state of mind is the most critical part.

Stoics practiced what are known as “spiritual exercises” and drew upon them for strength (Note from Tim: I dislike the word “spiritual” for reasons I’ve mentioned before, but scholar Pierre Hadot explains it’s appropriateness here).

Let’s look at three of the most important such exercises.

Practice Misfortune

“It is in times of security that the spirit should be preparing itself for difficult times; while fortune is bestowing favors on it is then is the time for it to be strengthened against her rebuffs.”
-Seneca

Seneca, who enjoyed great wealth as the adviser of Nero, suggested that we ought to set aside a certain number of days each month to practice poverty. Take a little food, wear your worst clothes, get away from the comfort of your home and bed. Put yourself face to face with want, he said, you’ll ask yourself “Is this what I used to dread?”

It’s important to remember that this is an exercise and not a rhetorical device. He doesn’t mean “think about” misfortune, he means live it. Comfort is the worst kind of slavery because you’re always afraid that something or someone will take it away. But if you can not just anticipate but practice misfortune, then chance loses its ability to disrupt your life.

Montaigne was fond of an ancient drinking game where the members took turns holding up a painting of a corpse inside a coffin and cheered “Drink and be merry for when you’re dead you will look like this.”

Emotions like anxiety and fear have their roots in uncertainty and rarely in experience. Anyone who has made a big bet on themselves knows how much energy both states can consume. The solution is to do something about that ignorance. Make yourself familiar with the things, the worst-case scenarios, that you’re afraid of.

Practice what you fear, whether a simulation in your mind or in real-life.

Then you, your company, and your employees will have little left to keep you from thinking and acting big.

The downside is almost always reversible or transient.

Train Perception to Avoid Good and Bad

“Choose not to be harmed and you won’t feel harmed. Don’t feel harmed and you haven’t been.”
-Marcus Aurelius

The Stoics had an exercise called Turning the Obstacle Upside Down. What they meant to do was make it impossible to not practice the art of philosophy. Because if you can properly turn a problem upside down, every “bad” becomes a new source of good.

Suppose for a second that you are trying to help someone and they respond by being surly or unwilling to cooperate. Instead of making your life more difficult, the exercise says, they’re actually directing you towards new virtues; for example, patience or understanding. Or, the death of someone close to you; a chance to show fortitude. Marcus Aurelius described it like this: “The impediment to action advances action. What stands in the way becomes the way.”

It should sound familiar because it is the same thinking behind Obama’s “teachable moments.” Right before the election, Joe Klein asked Obama how he’d made his decision to respond to the Reverend Wright scandal. He said something like ‘when the story broke I realized the best thing to do wasn’t damage control, it was to speak to Americans like adults.’ And what he ended up doing was turning a negative situation into the perfect platform for his landmark speech about race.

The common refrain about entrepreneurs is that they take advantage of, even create, opportunities. To the Stoic, everything is opportunity. The Reverend Wright scandal, a frustrating case where your help goes unappreciated, the death of a loved one, none of those are “opportunities” in the normal sense of the word. In fact, they are the opposite. They are obstacles. What a Stoic does is turn every obstacle into an opportunity.

There is no good or bad to the practicing Stoic. There is only perception. You control perception. You can choose to extrapolate past your first impression (‘X happened.’ –> ‘X happened and now my life is over.’). If you tie your first response to dispassion, you’ll find that everything is simply an opportunity.

Remember–It’s All Ephemeral

“Alexander the Great and his mule driver both died and the same thing happened to both.”
-Marcus Aurelius

I understand that entrepreneurs need to dream big and have unshakable faith in themselves in order to do great things. But if recent Valleywag headlines are any example (Cisco Exec Makes Death Threat Over $4,000 Bike), the inhabitants of start-up land can probably benefit from some practice of humility and self control. Not that bad tempers and ego are new problems.

Alexander the Great conquered the known world and had cities named in his honor. This is common knowledge.

Stoics would also point out that, once while drunk, Alexander got into a fight with his dearest friend, Cleitus, and accidentally killed him. Afterward, he was so despondent that he couldn’t eat or drink for three days. Sophists were called from all over Greece to see what they could do about his grief, to no avail.

Is this the mark of a successful life? From a personal standpoint, it matters little if your name is emblazoned on a map if you lose perspective and hurt those around you.

The exercise Marcus Aurelius suggests to remedy this is simple and effective:

“Run down the list of those who felt intense anger at something: the most famous, the most unfortunate, the most hated, the most whatever: Where is all that now? Smoke, dust, legend…or not even a legend. Think of all the examples. And how trivial the things we want so passionately are.”

It’s important to note that “passion” here isn’t the modern usage we’re familiar with. From Wikipedia:

One must therefore strive to be free of the passions, bearing in mind that the ancient meaning of ‘passion’ was “anguish” or “suffering”, that is, “passively” reacting to external events — somewhat different from the modern use of the word. A distinction was made between pathos (plural pathe) which is normally translated as “passion”, propathos or instinctive reaction (e.g. turning pale and trembling when confronted by physical danger) and eupathos, which is the mark of the Stoic sage (sophos). The eupatheia are feelings resulting from correct judgment in the same way as the passions result from incorrect judgment.

The idea was to be free of suffering through apatheia or peace of mind (literally, ‘without passion)’, where peace of mind was understood in the ancient sense — being objective or having “clear judgment” and the maintenance of equanimity in the face of life’s highs and lows.

For those interested in browsing the Greek words used in Stoic writing that are often mistranslated or miscontrued in English, here is a glossary of common terms.

Returning to the point of the exercise, it’s simple: remember how small you are.

For that matter, remember how small most everything is.

Remember that achievements can be ephemeral, and that your possession of them is for just an instant. Learn from Alexander’s mistake. Be humble and honest and aware. That is something you can have every single day of your life. You’ll never have to fear someone taking it from you or, worse still, it taking over you.

Tim: To illustrate a few real-world examples, here is an email from me to Ryan as we were working on this post:

Thanks, Ryan. Read it all and ran over all the material again. I think we’re getting there. The piece should be uplifting and empowering without being defensive, so it will still take some working, but no worries. I’ll be reading Epictetus tonight for more ideas. The part that bothers me is the entire “Remember you’re small” bit, which doesn’t jive with start-up founders. To do huge things, I really think you need to believe you can change the world and do so better than anyone else in some respect. It is possible, however, to simultaneously recognize that all is impermanent: the transient pains, bad PR, disloyal false friends, irrational exuberance, hitting #1 on the NY Times, whatever. I think it’s about not dwelling on pain and not clinging to ephemeral happiness. Enjoy it to the fullest (this is where I disagree with some of the Stoic writings), but don’t expect it to last forever, nor expect some single point in time to make your entire life complete forever.

*****

Stoic writings are not arcane arguments for bespectacled professors—they are cognitive exercises proven to center practitioners. To humble them. To keep them free and appreciative.

Stoic principles are often practiced in rehabilitation clinics with alcoholics so that coping mechanisms don’t drive them to drink. One wouldn’t view their new perspective on life as pessimistic or limiting; we celebrate the fact that, for their first time in their lives, they are empowered and unburdened.

We’re all addicts in some respect, and we can all experience that same freedom.

You can be a Stoic, and joke around and have a happy life surrounded by what’s valuable to you.

In fact, that’s the ultimate goal.

Stoicism is Ideal for the Entrepreneurial Life

The Stoics were writing honestly, often self-critically, about how they could become better people, be happier, and deal with the problems they faced. As an entrepreneur you can see how practicing misfortune makes you stronger in the face of adversity; how flipping an obstacle upside down turns problems into opportunities; and how remembering how small you are keeps your ego manageable and in perspective.

Ultimately, that’s what Stoicism is about. It’s not some systematic discussion of why or how the world exists. It is a series of reminders, tips and aids for living a good life.

Stoicism, as Marcus reminds himself, is not some grand Instructor but a balm, a soothing ointment to an injury wherever we might have one. Epictetus was right when he said that “life is hard, brutal, punishing, narrow, and confining, a deadly business.”

We should take whatever help we can get, and it just happens that that help can come from ourselves.

To finish, I want to share some of my favorite Stoic reminders. Look at them as short, mental routines to run through often. Each is a quick reset to recalibrate yourself and be happy with the things that matter:

***

Marcus Aurelius

“So other people hurt me? That’s their problem. Their character and actions are not mine. What is done to me is ordained by nature and what I do by my own.”

“Today I escaped from anxiety. Or no, I discarded it, because it was within me, in my own perceptions—not outside.”

“When you wake up in the morning, tell yourself: The people I deal with today will be meddling, ungrateful, arrogant, dishonest, jealous and surly. They are like this because they can’t tell good from evil. But I have seen the beauty of good, and the ugliness of evil and have recognized that the wrongdoer has a nature related to my own–not of the same blood or birth, but the same mind, and possessing a share of the divine. And so none of them can hurt me.”

“Because your own strength is unequal to the task, do not assume that it is beyond the powers of man; but if anything is within the powers and province of man, believe that it is within your own compass also.”

***

Seneca

“‘What progress have I made? I am beginning to be my own friend.’ That is progress indeed. Such a people will never be alone and you may be sure he is a friend to all.”

“Show me a man who isn’t a slave; one who is a slave to sex, another to money, another to ambition; all are slaves to hope or fear. I could show you a man who has been a Consul who is a slave to his ‘little old woman’, a millionaire who is the slave of a little girl in domestic service. And there is no state of slavery more disgraceful than one which is self-imposed.”

“Count your years and you’ll be ashamed to be wanting and working for exactly the same things as you wanted when you were a boy. Of this make sure against your dying day - that your faults die before you do.”

“Nothing, to my way of thinking, is a better proof of a well ordered mind than a man’s ability to stop just where he is and pass some time in his own company.”

“Cling tooth and nail to the following rule: not to give in to adversity, never to trust prosperity and always take full note of fortune’s habit of behaving just as she pleases, treating her as if she were actually going to do everything that is in her power.”

***

Epictetus

“So-and-so’s son is dead
What happened?
His son is dead
Nothing else?
Not a thing.

So-and-so’s ship sank
What happened?
His ship sank.

So-and-so was carted off to prison.
What happened?
He was carted off to prison.
-But if we now add to this “He has had bad luck,” then each of us is adding this observation on his own account”

The Pakistani Four-Step
By Victor Davis Hanson
©National Review Online December 2008

We all know the Pakistani four-step:

1) Large parts of the country where al-Qaeda and its affiliates openly congregate are a "badlands," a "frontier," or a "tribal land," supposedly out of control of an otherwise concerned government, eager to stop terrorism, but too often impotent to do so—and extremely sensitive to charges that its intelligence services or military cadres might in some quarters be sympathetic to radical Islamists who destabilize democracies in nearby India and Afghanistan.

2) Western suggestions for more order are deemed illiberal support for military juntas; Western suggestions for more democracy are derided as naive calls for plebescites that will empower popular jihadists. Taboo is the suspicion that a large majority of Pakistani people sort of likes the idea that its homebred Islamists from time to time kill Hindus, Afghans, Americans, Christians, and assorted Crusaders and Jews. We are told ad nauseam that Pakistani public opinion concerning the U.S. is "at all time lows," never that U.S. public opinion toward Pakistan is even lower, or that we are more concerned about the present good will of a democratic India, than the disdain of an autocratic Pakistan where the 9/11 killers reside.

3) The suggestion of lunacy, as well as the notion of a "failed state," is not unwelcome, since it reminds the U.S. that it should continue giving billions in aid, both military and civilian, inasmuch as otherwise an unpredictable nuclear and Islamic Pakistan is not always in control of terrorists who might get fissionable materials, or, due to its religious zeal, might not necessarily behave according to the Cold War laws of nuclear deterrence, or because of its poverty can't be held to account.

4) When all else fails, the Pakistani Westernized elite simply blames the U.S., past and present: During the Cold War we armed dictators and jihadists alike (apparently the alternative of becoming a Soviet protectorate was preferable); during the war on terror we energized strongmen (apparently we were to accept that the architects of 9/11 were ensconced on Pakistani territory and free to destroy the Afghan democratic experiment). Taboo also is the suggestion that most of Pakistan's problems are self-created, and involve deep-seeded religious zealotry and intolerance, rampant corruption, a lack of transparency, and medieval practices of land tenure (always interesting to hear anti-American critiques from members of the Pakistani baronial class).

As I understand the subtext of U.S. current policy—we pay Pakistan billions for (a) locking up their nukes, (b) the privilege of hunting terrorists, largely, but not always, through drone missile attacks—and Pakistan has plausible deniability. (c) It deplores U.S. intrusions when we screw up and either kill someone too prominent or get caught on tape; and (d) we loudly deplore Pakistani terrorism when its terrorists go beyond killing a few Christians or diplomats and do something like Mumbai.

I suppose all this is sustainable, but a large number of Americans (who wonder why seven years after 9/11 the killers are still traversing Pakistani provinces) are getting tired of the same old, same old, and might wish to wash their hands of Pakistan—and out-source the problem to India.