Karma is a very unappealingly idealistic concept. It may be some innate cynicism on my part that colors the lenses through which I see karma, but I find traditional understandings of karma to be an unlikely dynamic in any version of the cosmos that is not self-servingly laced with a sufficiently toxic dose of anthropic bias to return very high LD50 numbers. The sort of bilateral and evenhanded “cosmic justice,” for lack of a better term, that is implied stretches the imagination a bit past the limits of suspended disbelief. However, performing a rather radical hemispherectomy on karma results in a substantially more compelling version of the dynamic. Negative karma, of a sort, seems quite common. One wonders if the surgeon responsible for the procedure warned the patient and his or her wards about the possibility of hemiplegia and vision issues following the surgery. As an aside, one also wonders what cosmic karma seizures looked like before the operation.

We can see negative karma at work all over, and acknowledged in the kind of trite wisdom that peppers Western culture from the cruder “A man reaps what he sows,” to the more refined and once removed ne quid nimis. Alarmingly, the concept of negative karma is woven right into the fabric of the universe. To wit:

Law Zero: If A and B are each in thermal equilibrium with C, A is also in thermal equilibrium with B.

“You must play the game.”

Law The First: The increase in the internal energy of a system is equal to the amount of energy added by heating the system, minus the amount lost as a result of the work done by the system on its surroundings.

“You can’t win.”

Law The Second: In a system, a process that occurs will tend to increase the total entropy of the universe.

“You can’t break even.”

Law The Third: As a system approaches absolute zero, all processes cease and the entropy of the system approaches a minimum value.

“You can’t quit the game.”1

If there were ever rules for a negative karmic system, these are they.

This unfortunate bit of physics, these ropes around the ring of the human condition, tend to strike fatally at the romantic heart, and provide fertile soil not just for purveyors of pithy and sardonic wit...

If someone points out to you that your pet theory of the universe is in disagreement with Maxwell's equations — then so much the worse for Maxwell's equations. If it is found to be contradicted by observation — well, these experimentalists do bungle things sometimes. But if your theory is found to be against the second law of thermodynamics I can give you no hope; there is nothing for it but to collapse in deepest humiliation.2

The second law of thermodynamics is, without a doubt, one of the most perfect laws in physics. Any reproducible violation of it, however small, would bring the discoverer great riches as well as a trip to Stockholm. The world’s energy problems would be solved at one stroke. It is not possible to find any other law (except, perhaps, for super selection rules such as charge conservation) for which a proposed violation would bring more skepticism than this one.3

Nothing in life is certain except death, taxes and the second law of thermodynamics. All three are processes in which useful or accessible forms of some quantity, such as energy or money, are transformed into useless, inaccessible forms of the same quantity. That is not to say that these three processes don't have fringe benefits: taxes pay for roads and schools; the second law of thermodynamics drives cars, computers and metabolism; and death, at the very least, opens up tenured faculty positions.4

...but also for charlatan rebels who wage a futile and seemingly ceaseless insurrection against the laws. This is a rebellion characterized primarily, I think, by myopic self-delusion.

I remember falling into something of a depression when a professor reminded me that more entropy is created through heat loss from the brain by the simple act of sitting and reading than is removed by the perfect absorption of the material. The prospects for avoiding the heat death of the universe looked bleak after that and, in this, I am clearly not alone in my occasional semi-despair. Moreover, these precepts are like to discourage the more romantic among us primarily because of a particular side-effect of hemispherectomy mentioned briefly above: interference with vision.

Negative karma seems to have a problem with granularity. With resolution. Any hope for some sort of cosmic delivery of social justice (even of the negative only variety) is doomed to disillusion the hopeful, for, at least in economic systems, that sort of justice is limited to the systems, not its actors. Having abandoned hope of any sort of positive karma effect, the quest of the populist becomes two-fold:

First, to sharpen the resolution of negative karma down to the sub-meter range, where individual market actors can be made to bend knee.

Second, failing the first, to convince the masses that the first law doesn’t exist.

A tremendous amount of effort and artifice goes into effectuating this second goal, and, particularly in the last three decades, in no two fields are these energies more fervent (and more wasted) than in politics and finance. Depressingly, the short-term success of these efforts depends in large part on two mental deficiencies. First, financial illiteracy. (This should frighten the astute finem respice reader, who will, doubtless, recognize how wide-spread this particular deficiency is). Second, willful self-dilusion. I am at pains to articulate any other scenario wherein so many accept so easily the existence of a unicorn that defecates Krugerrands. (Or that the existence of an auraflatulent creature would exert no meaningful, downward pressure on the price of gold).

This brings us to another common observation that seems a consequence of negative karma. “People often get the government they deserve.” This quote is, of course, a badly perverted version of an old concept, easily verified by the fact that it is attributed alternately to Thomas Jefferson,5 Alexis De Tocqueville,6 H. L. Mencken,7 and George Bernard Shaw.8 Despite all these references, it seems the closest origins must be Joseph de Maistre's “Every country has the government it deserves.”9

I would like to suggest, in Maistresque fashion, that the United States has gotten the banking system it deserves. And, indeed, the economy it deserves.

Yesterday, Falkenblog penned an entry titled “All Banks are Insolvent if You Think They Are,” noting:

In the past week, prominent internet economists Tyler Cowen and Paul Krugman suggested that banks are insolvent, meaning, the value of their assets is below the value of their liabilities. They offered no data to support this assertion, I presume they merely inferred it via the stock market. Unfortunately, they are definitely correct if investors refuse to roll over short term debt, many large banks are insolvent, but this is just a self-fulfilling prophesy true at any time in banking.

It's a difficult problem, especially because simultaneous to financial stabilization plans, we have vague stress tests that could indiscriminately wipe out banks, as any official proclamation a bank is insolvent implies, through the dynamics above, they are insolvent.10

Taken from this perspective, it should be easy to see that this system depends on confidence to such a degree that, once combined with a little miasma and a lot of opacity, the continued suspension of disbelief mandates willful nearsightedness of such a degree that it borders on blind faith. It is no mystery to anyone with a high school education that the financial system in the United States depends on fractional-reserve banking, and that this, in turn, depends on the willingness of the holders of a financial institutions short term obligations to leave them in place long enough for the bank to profit from its long term investments. When tangible reasons to maintain this stable disequilibrium begin to vanish, an all-out effort to preserve the fantasy of “solvency” begins to descend into the spinning depths of madness on its way towards the abyss. A long list of increasingly less-clever fictions is presented to buttress the illusion.

Of course, this pattern began long before the trouble started to seem obvious. Capital ratio requirements were rendered fictional by "off balance sheet" holdings. Reserve issues avoided with securitization. Risks made technically invisible by gaming a simplistic (and regulator endorsed) ratings system.

This is not to say that these financial innovations have no use, but the shocking ignorance with which their use was received is daunting.

Finally, only the willfully deaf will not hear the absolute roaring death rattle of a bank: when accounting changes are proposed to augment the imagined value of the bank’s assets. While the hint that a much larger bank (the Fed or the Treasury) might exchange the questionable assets of a smaller institution for liquidity should be mildly comforting insofar as it suggests a brief delay for the day of reckoning, even a whisper that mark-to-market might be suspended in favor of mark-to-mythical, or “hold-to-maturity” values (creating the wonderfully recursive fiction that any present crisis of the sort that would require the bank to sell its long term assets simply doesn’t exist and therefore there is no need to discount the long term assets before their maturity)11 should end all discussion. The absurdity of “stress tests,” (essentially a set of temporary accounting rules designed, in the absence of any self-respecting auditor who will sign off, to emboss the balance sheets of selected banks with the Great Seal of the United States, whatever that is worth today) boggles the mind even before their underlying assumptions are scrutinized.

But this is exactly the financial system the United States deserves. For decades, investors have gleefully looked away while balance sheets became more and more opaque. While leverage became more and more significant. Firms can hardly be blamed for providing the intoxicating spin-swill that investors happily guzzled by the pitchbookfull. It worked. Absurd accounting treatments were routinely given the nod. Those questioning same faced an uphill battle. It is a compelling reminder of how serious has become the national anopsia epidemic that accounting rules and economic theories should become the targets of blame.

Likewise, industrial policy-making by the political class has been permitted an alarming deal of latitude in the last half-century, so much so that it is nearly impossible to find a citizen who will admit that the injection of nearly $5 trillion into the housing market12 (enough to capture in excess of 41% of the residential housing market by 2008) with artificially low risk-adjusted rates of return might have inflated the market maybe just a little bit. This cognitive dissonance is curious, if not surprising, because many of the same citizens will readily agree that similar policies by the Federal Reserve, despite these being less directed at a single industry or sector, were a “really bad thing”™. No one seems willing to accept this sort of blame. Let's try it one more time, see how it works.

Astute readers of finem respice will recognize these weak dodges as blatant attempts to convince the masses that, even painfully recent evidence to the contrary, the first law does not exist. Who can blame talking heads and legislators for employing this tactic? The public has allowed it to work for decades. Spin has successfully sold the absence of the first law to millions. To change this suddenly is as if, after years of rational normality, one suddenly started whacking the dog on the head with a newspaper whenever it obeyed a command, is likely to cause frenzied confusion as the animal desperately tries going through the litany of tricks, increasingly decoupled from the formerly-correct command stimuli, that used to work in the desperate hope that whatever insanity has begun can simply be rebooted back into the previous reality if the correct new pattern of old tricks can be uncovered by trial and error. At this point the astute reader may ask themselves: “Have I seen anything like frenzied confusion lately?”

How about concepts like:

• Paying $650 billion to make healthcare cheaper
• Using debt to deleverage the country
• Increasing taxes on small business during a recession
• Making green energy more efficient by making most other energy more expensive (a $6.7 trillion gross and $4.2 trillion net delta over 40 years)
• Boosting taxes on big oil while...
• ...attempting to use the 60 day supply in the Strategic Petroleum Reserve to meaningfully reduce oil prices
• Injecting more debt into housing to reinflate housing...
• ...while pushing for cramdowns and changes in bank recovery seniority likely to crash the value of mortgages and mortgage securities, and...
• ...providing homeowners with an incentive to default
• Convening a Fiscal Responsibility Summit while...
• ...generating a $1.3 $1.5 $1.75 trillion dollar deficit this year and increasing spending over the CBOs already painful projections by some $5 trillion over the next 10 years

A wounded animal is a dangerous beast. A wounded sovereign, far worse. As illusion begins to fail, other laws must be attacked. Likely next is the second law. Pay caps, yes, but what when these produce the inevitable entropy of talent drain? What will be the next plan to stem the slow creep of this entropy? Is it any wonder tax collection and capital flight has suddenly become the object of such hysterical obsession? Or that the fantasy of 2-3% growth in 2010 is delivered with a straight face?

Until market actors are dispossessed of the fantasy- maintained fanatically by the political class- that investing is (or can or should be) an easy free lunch, we are doomed to endure such shenanigans. And, unfortunately, if you will excuse the phrase, negative karma, she is a bitch, and she bites none harder in the long-term than those who flaunt her in the short. Delay and delay we may, but back will it swing, harder still, to return another day.

1. 1. These lighter summaries are often attributed to the Baron Charles Percy Snow, CBE.
2. 2. ”The Nature of the Physical World 1926-1927,” Sir Arthur Stanley Eddington (1930).
3. 3. "Thermodynamics," Ivan P. Bazarov (1964).
4. 4. ”Concept Going Into Reverse,” Seth Lloyd, Nature (August 26, 2004).
5. 5. And while this attribution is appealing, it is difficult to document. Related concepts, though they severely torture the reference are expressed by Jefferson elsewhere. To wit: "No interests are dearer to men than those which ought to be secured to them by their form of government, and none deserve better of them than those who contribute to the amelioration of that form." Thomas Jefferson to M. Ruelle (1809). "Let us deserve well of our country by making her interests the end of all our plans, and not our own pomp, patronage and irresponsibility." Thomas Jefferson to Albert Gallatin (1802).
6. 6. Often cited as appearing in Volume I or Volume II of “Democracy in America,” but if any phrase resembling this exists in the original French it is deeply concealed in elaborate prose and even the Reeve translation bears nothing obviously resembling the concept.
7. 7. The actual quote by Mencken is “Democracy is the theory that the common people know what they want, and deserve to get it good and hard.” “A Mencken Chrestomathy,” Henry Louis Mencken (1949). The same work includes the curt: “Nature abhors a moron.”
8. 8. ”Democracy is a device that insures we shall be governed no better than we deserve.” This, too, is difficult to document precisely.
9. 9. Literally “Toute nation a le gouvernement qu’elle mérite.” (“Every country has the government it deserves.”) Letter to Monsieur le Chevalier de [...] (August 15, 1811). As quoted in “Lettres et Opuscules Inédits du Comte J. De Maistre,” (1869).
10. 10. ”All Banks are Insolvent if You Think They Are,” Falkenblog (March 1, 2009).
11. 11. It appears that Bank of America has managed to delay admitting losses of $44 billion on loans in this way. “BofA carries loans $44 billion above market value,” Elinor Comlay, Reuters (February 27, 2009).
12. 12. ”2008 Report to Congress,” Office of Federal Housing Enterprise Oversight (April 15, 2008). Interested finem respice readers may wish to compare this figure to the size of all public debt held by the government in the same period for a little perspective.

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