Program Note for The Lehman Trilogy

The Lehman Trilogy opened in New York last night. I urge everyone who can to check it out, and quickly, because the run at the Park Avenue Armory last only about a month. Check here for details: http://www.armoryonpark.org/programs_events/detail/lehman

Two program notes were not run due to a miscommunication between the various parties involved. Like a Lannister, however, the Armory honored its commitment to pay me for the piece, which I see no reason to allow to lay dormant, unread, on my hard drive. So here is what I submitted:

Imprisoned by ideology and conceptual confusion, economic growth and development today mystify. Henry Lehman and his contemporaries labored under no such constraints, correctly equating America with abundant economic opportunity.

The Constitution consorted with Alexander Hamilton’s policies, which included anchoring the dollar to silver, funding the national debt, and establishing the Bank of the United States, to produce a national government energetic enough to protect Americans from foes foreign and domestic, but insufficiently powerful to threaten Americans’ liberties. Before Hamilton left Treasury, privately-owned stock exchanges, banks, and insurers formed to provide the financial infrastructure needed to increase agricultural yields, build the nation’s transportation infrastructure (toll bridges, canals, and turnpikes, followed in the 1830s by railroads), and jumpstart America’s industrial evolution.

Expecting to reap as they sowed, Euroamerican males, as well as non-trivial numbers of women and free people of color, worked harder and smarter than ever before to accumulate more assets than liabilities, i.e., to build net worth or “capital.” De jure barriers to enterprise were few, so competition ruled. Many contented themselves with the small but steady profits of the average artisan, farmer, or retailer by keeping pace with innovations others developed. Some strove for more, a few by cajoling favors from government, but most by developing new goods or producing existing ones more efficiently.

Most Americans abhorred, if not slavery, then the fact that the South was ruled by, and for, slaveholders. Many native-born, slave and free, left if they could, as it was no place for aspirants or those interested in their own health. The South’s disease environment, worsened by infectious slaves circulating in the infernal internal slave trade, destroyed many lives. The Lehman brothers were lucky to sit shiva only once in Alabama.

The surviving brothers belatedly fled to Manhattan, which only recently had overtaken Philadelphia as America’s financial and commercial capital. Success in Gotham, though, was not guaranteed, as the city remained subject to epidemics, riots, and conflagrations. Moreover, the economy experienced troubling reversals, like those following financial panics in 1819 and 1837. Another panic, in 1857, initiated the sequence of events that led to the Civil War, which in four years destroyed the South’s economy and proved cotton no monarch.

Rooted in brutal exploitation of land and labor, the South’s agricultural and industrial sectors could not match the dexterity of Northern enterprise, which quickly adapted to wartime conditions. By switching from retailing cloth and agricultural implements to brokering cotton, coffee, and other commodities, the Lehmans proved themselves more Billy Yanks than Johnny Rebs. After Emancipation, the South continued to exploit its laborers via systems described as “worse than slavery” and “slavery by another name” -- convict labor, debt peonage, and Jim Crow. Even with the aid of Lehman and other Northern capital, its economy would not catch up to that of the North for over a century.

Under Philip, the Lehman brothers’ partnership became a full-blown investment bank, an intermediary that resold to investors the stocks and bonds that corporations issued to fund their expansion. Newly-issued securities were safely underwritten by packs of banks, called syndicates, that exposed to loss only a portion of the Lehman’s own capital and the deposits of wealthy individuals and institutions. (Small businesses and poorer individuals banked with building and loan societies, mutual savings banks, and, a little later, credit unions.) Scale, volume, and time, not excessive risk, created and safeguarded the Lehman fortune.

After the Great War, entertainment investments proved shrewd. As Americans’ incomes continued to climb, so too did demand for leisure goods, like films, radios, and eventually televisions. When Depression struck, the still piddling federal government feared bailing out investment banks. The Federal Reserve, the nation’s putative lender-of-last-resort, did not even bail out the 9,000 commercial banks that failed during the 1930s! Nonetheless, FDR pinned blame for the unprecedented economic downturn not on government policies but on investment banks, which survived the stock market crash to the extent that they were just middlemen. After the economy rebounded, investment banks thrived again because they managed to write New Deal regulations that limited underwriting competition from commercial banks.

Postwar, investment banking profoundly transformed. As family dynasties like Lehman’s weakened, partnerships conceded to publicly-traded corporations, dramatically altering bankers’ incentives. To steward resources for ensuing generations, partners nurtured long-term client relationships. Hirelings, by contrast, sought enormous bonuses based on short-term performance, which created macho corporate cultures that demeaned women, extolled the exploitation of clients, and encouraged risky international expansion and speculative trading.

Due to the unpredictability of markets and the number and size of the risky bets taken, eventual failure was assured. But big bonuses and bailout expectations bested prudence. In 2008, the federal government, grown powerful continuously fighting hot and cold wars, bailed out almost everyone, except Lehman.

Universities Should Put More Skin in the Game

I thought that, once again, I would delight readers with an earlier draft of a piece published online elsewhere. This is partly cya on my part (sometimes important stuff has to get cut for word length reasons) but also shows all the work that goes into polishing pieces for publication. My name is not R.E.Wright for no reason! Finally, some readers might find this simple list easier to follow.

The published piece just came out on the Martin Center blog and is called "Universities Should Invest in Their Students, Not Securities."

Seven Reasons Universities Should Invest in Their Students, Not Securities

Tuition-driven universities should lend their students the money they need to attend their institutions. There are seven major reasons why they should do so.

11.      Skin in the game

Warren Buffett’s billions stand testament to the wisdom of ensuring that people and institutions stand to lose if they don't deliver as promised. Alas, misaligned incentives plague higher education because major players have little “skin in the game.” Most professors and administrators are good people but that means little at schools that need student tuition payments in order to survive. The existential imperative at many American universities is to get -- and this is a direct quotation I have heard more than once in my quarter century in higher ed -- “asses in classes.” What happens to students once they leave is of little concern to such schools, the majority of America’s institutions of higher education.

22.      The Economics of Information

Universities know more about their students than banks or the federal government ever could. They are therefore in the best position to make loan decisions, on which more below. In the securities market, by contrast, universities hold no advantages.

33.      Leadership in the Incentive Revolution

Many universities purport to educate business, political, and social leaders but often fail to lead reform movements themselves. Instead of preaching from their Ivory Towers, universities can show other lagging sectors that meaningful improvements can be had by changing root incentive structures.

Healthcare providers, for example, get paid for performing services, needed or otherwise, effectively or not. In the absence of robust competition based on price and quality, their profits are maximized by keeping people sick, not restoring their health. Misaligned incentives also plague government, the agencies of which are rewarded for accomplishing tasks like keeping endangered species endangered, wasting travelers’ time without improving their security, and ensuring that Indians living on reservations remain impoverished.

Doctors and bureaucrats aren't any worse people than the rest of us. Most work hard to provide for their families, but even saints could not overcome the backwards incentives baked into how they do their jobs. That’s why the government itself admits that the Department of Education is a failure and why the healthcare sector sucks almost 1 in every 5 dollars of GDP into its gaping maw while producing lackluster results.

If higher education can lead an Incentive Revolution that shores up the economy’s weakest sectors, it should be able to recoup some of the social prestige it has lost in recent decades.

44.      Precedent

Many manufacturers of big ticket goods designed to the increase the purchasers’ income, like General Motors and General Electric, directly or indirectly lend the purchase price of their products to their customers. Many could obtain financing elsewhere, but the loan binds the interests of the manufacturers to those of their customers because if the products are not worth the price, purchasers are more likely to default on the loans. Extending a loan therefore serves as a sort of quality guaranty.

The same holds for universities, at least one of which, Hillsdale College, indirectly lends to its own students through private loan funds. (At least two dozen well-endowed universities provide all or most students with outright grants. Bully for them and their students but they are far from the norm.)

55.      Independence from Washington

Hillsdale and other colleges and universities do not allow their students to receive federal financial aid so they can remain free of federal bureaucrats. Many tuition-driven universities are now also beginning to pine for the freedom to teach their own students as they see fit. The backstory here is important, if you do not already know it.

Superior programs that meet real world needs fill the seats with good students but creating such programs is difficult and expensive. So many schools opted instead for the illusion of quality combined with shrewd marketing. They filled seats by telling parents that their kids will be safe and get a job after graduation while convincing prospective students that fun awaits.

If and when Joe and Jane graduated, often without the skills or knowledge necessary to contribute much to businesses, graduate programs, or nonprofit organizations, however, they didn’t land high paying jobs and felt burdened by debt. They complained, as did parents eager to reclaim their basements and employers desperate to hire quality workers.

Even when the economy booms, more than one in ten graduates, and perhaps as many as one in three, default on their student loans, which their alma maters never prepared them to understand, much less pay off. Taxpayers heard about the worst abuses and rightly sought redress. Most Americans, though, swilled down the “everybody must get a college education” Kool Aid, so instead of ending federal subsidies for higher education they called instead for “accountability,” which Uncle Sam translated into increasingly onerous regulations.

This being Murica, the Department of Education didn't dare tell professors what they could do in their classrooms. Instead, it told state regulators and regional accreditors to pressure university administrators into accepting “the assessment agenda.” Administrators, in turn, now threaten faculty members with accreditation or job loss if they do not comply. Yes, job loss. Most faculty members are now untenured, contingent faculty who can be terminated for any reason.

If the “assessment agenda” had been scientifically constructed and carefully implemented, higher education might improve. But it was not. A charitable interpretation is that the directions set forth by the good, hardworking bureaucrats at the Department of Education got garbled as they worked their way down to poor professors, many of whom were blindsided by demands that they have to create “student learning outcomes” and then “assess” them. That of course is what they have been doing for centuries, but apparently not in ways sufficiently “legible” to government bean counters.

Some administrators and professors welcome the assessment dictates, supposing that it will induce older professors to retire and lazy ones to finally update their courses and get off the bottom of Bloom's revised taxonomy, i.e. to move away from rote memorization and towards analysis, evaluation, and creativity. Other professors believe that while assessment might inspire positive change at some margins, under the imperative of filling seats most reforms will remain cosmetic, or even counterproductive because the lower levels of Bloom’s are the easiest to assess.

Most importantly, though, the regulatory push for assessment shows that the federal government wields the proverbial “power of the purse” over all institutions of higher education dependent on tuition dollars and their consort, federally guaranteed student loans. Rather than blithely jump down Orwellian and Veblenian assessment rabbit holes into Wonderland, universities could go back to first principles and rearrange their incentives away from merely filling seats. To do that, they need to invest in their own students, not in the stock, bond, or derivatives markets.

66.      Polycentric Regulation

Once properly incentivized by placing their own skin in the game, universities would soon do whatever it takes to enable, and induce, their students to repay them. If their students repay, schools will continue to exist; if their students default, schools will fail, sooner or later, no monolithic, top-down regulation necessary. Importantly, schools that fold or downsize will free up resources (like professors) to try something new.

Similarly, the proposed reform would eliminate the need for stringent entry barriers into higher education. Students and their employers, not accreditors (Who are those people anyway? If they are such pedagogical experts, why aren't they teaching or administering?), will decide which schools pass muster and which do not. Professors unable to find good jobs at existing universities would be free to establish their own institutions, perhaps by pooling their resources in professional partnerships.

77.      Ease of Implementation

Universities should find investing in their own students instead of in securities markets relatively easy. Some already have the basic infrastructure in place because they provide grants that revert to loans if students leave before graduation or fail to fulfill occupational requirements after graduation, like teaching in a public school or practicing medicine in a rural area. Loan offers would come as part of the financial aid package. All students should have to put up some cash, their own “skin in the game,” but the amount, as well as the major loan repayment terms (interest rate, maturity, default penalties, etc.), should be a matter of competitive negotiation.

Each university will develop its own plan, but I suspect you'll see much more curricular emphasis placed on ethics and personal finance. With investments in the form of loans rather than income sharing, I would not expect to see a dramatic move away from the liberal arts or preparing students for lower-paying careers like teaching or the ministry. Financially successful alums can still be urged to donate, but to stay viable universities will only need their graduates to service their debts.

I suspect that universities that choose to invest in their students will learn how to integrate the liberal arts into career-oriented majors like business, education, nursing, or the performing arts. In other words, instead of forcing students to take random “general education” classes in anthropology, economics, history, or philosophy and merely asserting that they are relevant to various professions, professors will demonstrate their relevance by teaching courses in business history, the philosophy of education, the anthropology of nursing, the economics of entertainment, and so forth. Some schools will find other paths to success (or failure), creating the diversity at the heart of polycentric approaches to complex problems.

New universities, or existing ones with endowments insufficient to fund operations for five or more years, can invest in their own students by borrowing money, relending it to their students at a higher rate, and capturing the gross spread, like a bank. State governments might consider endowing schools with enough cash to allow them to invest in their own students in lieu of annual appropriations. Generally speaking, a one-time subsidy for a specific purpose causes less distortion than annual subsidies.

In any event, it is high time universities took direct responsibility for the quality of their product by funding their own students and telling Uncle Sam his deep pockets and meddling ways are no longer welcomed.

Robert E. Wright is the Nef Family Chair of Political Economy at Augustana University in Sioux Falls, South Dakota, and the author of 18 books on U.S. business, economic, financial, and policy history.

A Subversive Take on Captive State

A Subversive Take on Captive State

The apparent intent of the creators of the recently released film Captive State is that all it will take to
destroy the evil capitalist system currently destroying both humanity and the environment is for a
highly-placed, well-intentioned insider like John Goodman to spark a revolution.

My interpretation, though, is rather more subversive.

The movie’s aliens come not to annihilate or even enslave humanity but to become the alpha dogs
of our current world, or at least the wet nightmare crony version of it conjured by many on the Left.

The unequivocal message is that although the aliens and their capitalist betas employ super scary
weapons and tracking technologies, they can be defeated with ingenuity, their own weapons,
and the blood of a few martyrs.

While it seems likely that people throughout the globe indeed would try to expel alien overlords,
termed “Legislators” in the movie, if they had any hope of success, the global proletariat has
yet to unite or otherwise cast off the “chains” Marx imagined.

Communist revolutions occurred in backwards places like Russia, China, and Cuba because most
people in those places had nothing to lose. That is clearly not the case in the developed world.
America may yet slide into an alcohol soft middle aged socialism but it will be due to intellectual laziness,
not violent revolution, and certainly not this so-so movie.

Applying Game Theory Models to Games (Athletic Contests)

Applying Game Theory Models to Games (Athletic Contests)

By Robert E. Wright, Nef Family Chair of Political Economy, Augustana University for the 30^th Annual Teaching Economics Conference, McGraw-Hill Higher Education/Robert Morris University, Moon Township, Pennsylvania, 22-23 February 2019.

“In theory, there is no difference between theory and practice. In practice there is.” Or so baseball legend Yogi Berra once reputedly quipped. He may have said that -- it sounds like Yogi -- but he wasn’t the first to utter those words, an upperclassman at Yale in 1882 was (https://quoteinvestigator.com/2018/04/14/theory/). Similarly, I am not the first to apply game theory to sport (see, e.g., Mottley 1954) but I hope to add to the discussion by suggesting that game theory’s application to coaching territorial team sports like basketball, football, hockey, lacrosse, rugby, soccer, and water polo, can be powerful, but it is not a panacea and even can be counterproductive. Game theory is often more powerfully applied to various non-territorial sports, including baseball (see, e.g., Weinstein-Gould 2009; Turocy 2014) and volley sports like tennis and volleyball (Lin 2014).

I would not call strategic problems in the actual playing of territorial team sports “wicked,” in the technical sense of “wicked social problems” that have no stopping rule, have solutions that are only better or worse rather than right and wrong, and so forth (Peters 2017). But they are certainly “complex” problems a la Nason (2017) and even “chaotic” a la Fergus Connolly (Connolly and White 2017), who incidentally consults for the Robert Morris University Colonials, among other elite level teams. His hyper-interdisciplinary systems-within-systems approach to territorial sports forms the core of the masters course that I teach at Augustana University on the Business of Coaching.

But Connolly’s approach does not make absolutely clear to readers that successful coaches must engage in strategic competition, where strategy refers to the anticipation of the moves of their opponents and not some vague notion of planning, as in the term “game plan.” Game theory, which of course is intrinsically interesting for many students and a key tool in the honing of strategic sensibilities (Dixit 2005), barely registers in Connolly’s otherwise seminal/ovanal/gaminal 2017 opus, Game Changers.

Two player/team/coach games, especially zero-sum ones, seem like a natural way to apply game theory to sport. The realities of on-field competition, however, quickly reveal the shortcomings of simultaneous one-shot games, much as happened when Chicken was applied to the Cuban Missile Crisis (Zagare 2014) and the Prisoner’s Dilemma (PD) was applied to the actual behaviors of criminals (Khadjavi and Lange 2013). In both instances, it quickly became apparent that PD and other simple games exist within larger game structures and cannot in themselves always satiate real world decision makers. For example, HBO’s The Wire showed that the simple PD description we all work through in class (a la Tucker 1983) is, in the reality of Baltimore’s drug scene, embedded in another game, actually referred to on the street as The Game, where “snitches get stitches,” or worse, creating a payoff structure where players keep their mouths shut no matter what (Cherrier 2012).

Simple games also break down due to the speed of competitive play. Time to think through payoff structures does not exist; reactions must be instinctive to be fast enough to matter. The best that can be done is for coaches and players to think through and model various game scenarios and then drill the rational responses, much as ex-NHL player Nicklas Lidstrom has done regarding one-on-one plays in hockey, and so forth (Lennartsson, Lidstrom, and Lindberg 2015).

Many games applicable to sport have mixed strategy equilibria and hence dissolve into Minimax with random strategy solutions (see, e.g., Flanagan 1998), a fact that the offensive coordinator of the Los Angeles Rams seems not to have fully grasped during the recent Super Bowl LIII. Several studies have shown that minimax predictions do not hold up well in the laboratory (Levitt, List, and Reiley 2010) but do on the field, at least where strategy randomization and outcomes can be precisely measured, as in tennis serves and soccer penalty kicks (Palacios-Huerta 2003). Similarly, McGarrity and Linnen (2010) leverage a natural experiment, the injury of a starting quarterback, to show that NFL football teams play the equivalent of a matching pennies game wherein the defense tries to match the offense’s decision to run or pass and the offense tries to not match the defense’s decision. I suggest that football teams actually run three types of plays -- run, pass, and hybrids like draws, options, play action, and screens -- so a rock-paper-scissors type game might be even more realistic (Spaniel 2011).

In any event, working through mixed strategy examples can be helpful for aspiring coaches to see that randomness can be optimal under specific conditions. That does not alleviate their angst concerning their replacement by, if not just computers, then nerds using computers (Davenport 2016; Jones 2018), but it can help them to overcome behavioral biases like the risk aversion that apparently induces baseball pitchers to throw too many fastballs (Kovash and Levitt 2009), football coaches to punt too frequently on fourth down and to run the ball too much, and basketball players not to attempt as many three-point shots as they should (Fichman and O’Brien 2018).

The best applications of game theory to territorial sports often occur off the field but can still be of immense importance to coaches. Aspects of sport design, a huge arena ably surveyed, albeit over 15 years ago now, by Szymanski (2003), are amenable to game theoretic modeling. How to keep up fan interest is a core concern as it forms the basis for all sports funding, except in amateur pay-to-play leagues, in which case maximization of player and/or parent utility is paramount. Most research suggests that fans want the home team to win, but in a close contest, rendering mechanisms for ensuring something like on-field parity of prime interest. That leads in many fruitful directions, like rules for demoting teams from the top tier, as in European soccer leagues, and drafting new players. Forty years ago, for example, Brams and Straffin (1979) showed, with a simple PD game and four fairly realistic assumptions about complete information and incomplete collusion, that North American-style drafts could lead to Pareto inefficient outcomes. As Syzmanski (2010) has shown, however, many early treatments of competitive balance made unrealistic assumptions about the correspondence between individual athletic talent and team wins. In sum, the sum of individual talent can be greater than, equal to, or less than actual team performance.

The need to maintain competitive balance also raises the largely intractable issue of doping, or the use of performance-enhancing substances (Kirstein 2009). Frank Daumann of the Institute for Sports Science in Jena, Germany, recently (2018) offered a game theoretic analysis of the doping strategies of two athletes that can be easily modified to a scenario where two head coaches must decide whether or not to allow their players to use performance enhancing substances not explicitly banned by the league or conference in which they compete. Benefits of doping include a higher probability of winning and hence of job retention (Fizel and D’Itri 1997), advancement, bonuses, and a burnished reputation. Costs include the price of the substances themselves and reductions in athlete health, both presumably small in present value terms, and the risk of a tarnished reputation (Butler 2014). This, Daumann shows, could be modeled as a one-off PD such that both coaches will decide to allow their players to dope although both teams would be better off if they did not use performance enhancing substances.

But of course in team sports, especially the territorial ones considered here, athletes may try to free ride on their teammates. In other words, simply because a coach signals that athletes may dope does not mean that they will choose to do so as players may hope that enough of their fellows will bear the costs of doping to improve team performance without having to bear the costs themselves.

The prospect of free-riding raises the specter of coaches forcing their players to dope, or leveraging asymmetric information to trick them into doping (Johnson 2003), either of which would radically change the payoff structure the coach faces as he or she may have to bear all of the cost of the enhancement substances and any negative social and reputational effects if league officials, competitors, or fans discover the doping, which seems more likely if the coach forces it than if he or she simply allows it (Dunbar 2014). Coercion seems unlikely, moreover, because team sport coaches regularly face free rider problems in a variety of areas and have techniques for mitigating them analogous to the techniques used by those drug dealers in Baltimore that I mentioned earlier.

Like the leaders of drug dealers and criminal gangs (Spergel 1990), organized crime “families” (Shvarts 2002), and most military units (Rose 1945-46; Montgomery 1946), coaches reduce free riding by creating a culture of trust, an ideology of service to others, and pseudo-familial bonds through various rituals and shared adversity. In effect, they try to reduce the economic rationality of their athletes by convincing them that they love their teammates more than they love themselves (Connolly and White 2017), thus inducing them to place a large weight on their colleagues’ well-being in their own utility functions (Bergstrom 1997). Game theory aficionados will recognize the similarities of this with the Battle of the Sexes, the iconic version of which features a husband who wants to go to a football game and a wife who wants to go to the opera but both prefer that outcome only if they can persuade the other spouse to attend with them (Hahn 2003).

Of course, cultural manipulations sometimes fall short or break down under stress, so coaches have other tools for reducing free riding. One I call the wildebeest solution after a technique that wildebeest herds reputedly use to cross crocodile-infested waters during their great migrations across the African savannah. They force the putatively oldest, weakest, least fertile member of the herd into the waters first. As the voracious crocs devour her, the younger, stronger, healthier members of the herd safely cross (Sapolsky 2017). No strategic choice is involved as the wildebeests force one of their number into the river first, but costly signaling may be involved. The key to survival is to appear not to be the oldest, weakest member of the herd or, in our case, team, where death-by-crocodile is substituted with getting cut from the team. Coaches, in other words, can reduce defection, free riding, and shirking by making it clear that players who do not signal that they are “team players,” who do not stand ready to forgo the temptation to free ride, may end up making the ultimate sacrifice (Spence 1973).

Despite some recognition that Braess’s paradox may apply to territorial team sports like basketball (Skinner 2010), superstar athletes know that coaches cannot costlessly bench them, much less cut them from the team, so some may shirk or defect by going for individual statistics instead of wins (Berri and Krautmann 2006; Krautmann and Donley 2009), which is why it is wise to make team performance, short of championship bonuses, a major component of elite athlete compensation (Frick 2003). For most players, though, fear of being labelled the wildebeest is enough to induce them to take one for the team, even if that means injecting or imbibing some new or unusual substance not yet banned.

In sum, coaches and other sports administrators can leverage the insights of game theory to improve competitive outcomes but they need to employ theory carefully and switch toolkits when need be, or face becoming the expendable wildebeest themselves.

References

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