An occasional essay by Bruce Baker, presented to the Center for Integrity in Business
All economic theories are built on presumptions about human nature. What happens when our understanding of human nature goes digital? What happens to our ideas about the integrity of economic behavior when human nature becomes reinterpreted through the lens of the new digital society?
Biology, ethics and economics are converging at this intersection and are pointing toward a new digitized version of human behavior and ethics. Our ability to analyze biological data, to unravel the genome and study the brain through chemistry and physics poses the possibility of digitizing the famous thesis that human behavior can be interpreted in terms of an idealized Homo Economicus, or “Economic Man.”
Economic Man/Human is the big idea that enabled economics to branch out from philosophy and claim to be a scientific academic discipline in its own right. This transformation in economics emerged during the 19th century, spurred by John Stuart Mills’ efforts to formulate political and economic policy by analyzing the human “as a being who desires to possess wealth and who is capable of judging the comparative efficacy of means for obtaining that end.”
The classical idea of Homo Economicus has generated much practical work in economics. It has also been pronounced dead, or at least endangered, countless times over the past 200 years. It is of course an oversimplification, and that’s generally the nub of the problem with economics. People are too complicated to be reduced down to mathematical descriptions of some idealized utility functions. Peter Drucker wrote The End of Economic Man in 1939, for one example. Not even John Stuart Mill, who is generally credited with moving economics in this direction, believed in Homo Economicus as a valid description of human nature. He knew it to be an abstraction that failed to capture the passionate side of human motives.
Genetics, brain science and the analytics of “big data” are reformulating our understanding of human behavior however, and this suggests that we may expect the theory of Homo Economicus to be reinvigorated and have a long life.
Economists have gotten a lot of mileage out of theories based in the human capacity to make rational choices based on quantifiable utility functions. If only there were a way to quantify the irrational aspects of human behavior also, then there would seem to be no limit to frontiers open to economic analysis.
This is precisely the direction being proposed by new research such as that of John Coates, who writes in his new book of advances in neuroscience and physiology which explain what happens in the body and brain when people make irrational choices in stressful situations. Coates is a former derivatives trader from Deutsche Bank who now does research into the neuroscience of decision-making in financial markets. He comes to the conclusion that “irrational exuberance” of the sort that destabilizes financial markets can be probed and understood through better physiology and brain science. These new scientific capabilities point the way forward for theoretical applications of Homo Economicus.
The new and improved version of Homo Economicus will offer to analyze both the rational choices and the irrational reactions of consumers and market makers in terms amenable to data analysis. Consumers are already being treated as digital abstractions by marketing techniques such as Net Promoter Scores, in which their market value to a vendor or advertiser receives a numerical ranking based on their influence through digital social media. When these data are combined with digital formulations of human behavior based on analysis of biological reactions to any number of circumstantial stimuli, the capacity of the digital version of Homo Economicus would seem to be unlimited.
As always, these new technologies will bring with them a blessing and a curse. The blessing is obvious: enhanced abilities to build efficiency into markets and wisdom into regulatory policies. The curse will lie in the potential to subjugate human relationships to digital analysis in the marketplace. Every facial expression and vocal tick will be analyzed by the advertiser, and every human reaction will become open to more sophisticated forms of manipulation based in predictive theories.
As always, the challenge of using these new technologies and theories will be to recognize them as tools, but never as definitions of human nature. Human integrity resides ultimately in the imago Dei, in relationship with the Triune God. While physiology and neuroscience have a lot to teach us about how our bodies react to the stress of ethical dilemmas and financial choices, these sciences do not define what it means to be human. Only God can do that.
 Homo Economicus is better translated as “Economic Human,” as Joseph Persky notes as he elaborates on the origins of this idea. Persky documents academic usage of the Latin phrase Homo Economicus from at least as early as 1906. Persky, J. (1995). The Ethology of Homo Economicus. Journal of Economic Perspectives, 9(2), 221-231.
 Mill, J. S. (1836). On the Definition of Political Economy; and on the Method of Investigation Proper to It. London and Westminster Review, October 1836. Cf., Persky (1995: 223).
 Mill, J. S. (1836). Cf., Persky (1995: 223). Tomas Sedlacek explains this historical transformation in economics with great insight into the dismal consequences of attempting to separate economics from an ethical understanding of humankind. Sedlacek, T., & Havel, V. (2011). Economics of Good and Evil: The Quest for Economic Meaning from Gilgamesh to Wall Street. Oxford: Oxford University Press, USA.
 Coates, J. (2012). The hour between dog and wolf: Risk-taking, gut feelings and the biology of boom and bust. New York: Penguin Press.
Dr. Bruce Baker is Asst. Professor of Business Ethics at Seattle Pacific University. His previous work includes founding and leading high-tech companies, and serving as a general manager at Microsoft. For further information you may contact Dr. Baker at firstname.lastname@example.org.
First there was Occupy Wall Street, but now the noisiest protest seems to be coming from those who wish to occupy the Internet. The irony of it all is that this time, it’s the powerful corporations who are staging the sit-in (or ‘blackout’ or ‘shutdown’, as the case may be), ostensibly on behalf of grassroots consumers. The power brokers of cyberspace, led by Google and Wikipedia, have mounted a substantial protest against the anti-piracy bills being debated in Congress. The bills known as SOPA (Stop Online Piracy Act) and PIPA (Prevent Internet Piracy Act) have been attacked as threats to our freedom of speech and free market economics.
“Imagine a world without free knowledge…” begins Wikipedia’s protest page, “Right now, the U.S. Congress is considering legislation that could fatally damage the free and open Internet” [BBC News, NY Times, Jan. 19, 2012]. This must be some powerful bad medicine, if it threatens to kill the patient. At least, that seems to be the position taken by Wikipedia’s publicists.
Whether or not these pieces of legislation have been well-crafted is certainly open to debate. I’m not concerned here with the legalities, but rather with the moral stance of the corporate protesters. The invective being thrown at these bills calls into question the integrity of the internet companies’ response. What moral weight do their tweets and texts bear? Consider the source: these proclamations and accusations are voiced by the companies who make their living by building and driving traffic in cyberspace.
The protesters are careful, of course, to avoid any appearance that they are in favor of piracy. They don’t question the motivations or intentions of the legislation aimed at reining in the pirates out there far from our shores (China, Russia and the Middle East are frequently listed as pirate-friendly safe harbors).
Rather than offer constructive suggestions however for how to combat piracy, the corporate protests seemed designed to upset and rally people to the cry that this legislation may be bad for business. For their business, that is. Let’s be clear about that, because it was designed specifically to protect the business of other companies who produce the valuable content being peddled in cyberspace. One protester in San Francisco, representing an online travel company, put it plainly, “this legislation is bad, it would directly impact our company.” [NY Times, Jan. 19, 2012]
It’s the self-serving tone of such protests that raises the question of integrity. There is precious little moral content in the argument that what’s bad for my business is bad, regardless of how it affects others.
Of course the protesters do not mean to suggest that their moral footing is grounded in self-interest; rather, they imply that their moral authority stems from their concern for freedom as a general principle, as well as concern for the individual information consumers in particular. Of course, this argument is also suspect because their altruism seems to flow from concern for their own customers—the consumers of information services.
These moral arguments are weak. In the first instance, the argument for freedom could just as well be claimed by their opponents who argue for the freedom to earn a living and not to have their products stolen by pirates. Freedom of information is not an issue being questioned by the legislation; piracy is. In the second instance, concern for their own customers once again begs the question of whether the protests are self-serving.
A sincere moral argument rooted in altruism would take a different course. It would demonstrate motive and desire to help solve the piracy problem. It would demonstrate resolve and commitment on the part of the Board of Directors and management to help address a problem that is significantly undermining other significant businesses in our economy.
To protect one’s self-interest with defensive arguments lacks integrity to any source of morality higher than hunger or survival. True integrity recognizes a higher calling, namely, to act out of sincere concern for others’ welfare. That is why biblical notions of morality, based in kenotic self-emptying of self-importance, are just as critical to corporate moral authority as they are to personal integrity.
Perhaps the protesters had valid reason to question the structure of these bills. In that case they might have addressed those issues head-on in a manner which carried much greater moral strength. They might have shown integrity by demonstrating their sincere concern to solve the problem. They might have offered ways to strengthen their current anti-piracy policies. And yes, because “business is business”, this would most likely cost them something in the short run. But in the long run they would have demonstrated a concern for our entire economic system and not just for their own slice of it. They would also be living into the higher calling of integrity which flows from an understanding of the biblical call to be witnesses to a greater reality than pecuniary self-interest.
Bruce Baker is an Assistant Professor of Business Ethics at Seattle Pacific University.
Prices on homes in America fell dramatically starting in late 2006, after an unprecedented run up in prices over the previous eight years. The fallout from this drop was felt around the world in the worst economic recession since the Great Depression. Its impact seems to have a long “tail.” For example, global jobless rates remain high five years later. How can the price of a home in Topeka, Kansas, affect jobs and governments half a world away? What factors came together to cause this to happen? And what can we learn from it? How can we reflect on this as Christians? This is the story we will try to unpack. It is a story of multiple, seemingly unrelated strands which came together as a perfect storm.
In the early 1990s, the world was just emerging from a modest recession and a long run of “good times” began. The Internet was new and it was the beginning of the “dot com” boom. Many nations of the world moved forward economically. In 1995, the U.S. revised its Community Reinvestment Act, adding fuel to policies that encourage home ownership for all (a practice deeply rooted in government leadership from both political parties). Demand for housing increased and prices started to rise. The half-century trend of one percent annual home price escalation jumped to seven percent in 1998, a pace that continued until 2006. But the Community Reinvestment Act was only one trigger for this period of growth.
In 1999, the Glass-Steagall Act was repealed. Enacted after the Great Depression, it had separated the roles of commercial banks and investment banks; its repeal now allowed any bank to get into the investment business. Some argue this had a minor role in the investment crisis, as provisions of the Act had been eroded steadily since the 1980s; but the timing of this repeal makes it appear as at least one factor in the change of banking behavior.
The collapse of the tech bubble in 2000 was another key event. Leading up to that time, any company with “dot com” in its name could attract huge investment. But investors finally began to realize that even “dot com” did not change the rules of business. Companies still needed a viable product and still had to make money to survive, and many companies were exposed as shams. The tech market (NASDAQ) dropped from 5,000 in early 2000 to almost 1,000 a couple of years later in what was often referred to as the “dot bomb.”
This seemingly unrelated event connected to the housing boom in an interesting way. Investors seeking better growth in their portfolios responded to the “innovation of the market” in the form of investment products built on home mortgages. With the run up of housing prices, investors could move their money to a new kind of investment vehicle based on home values, including the collateralized debt obligation (CDO).
The first CDOs were created in 1987. A number of mortgages were put together in a package and sliced up so each CDO contained a small piece of many mortgages, reducing the risk of owning one particular mortgage. The value of the investment is represented by the risk of default on the mortgages and the potential increase in value of the homes represented in the package. Not much happened with this market for several years until a spike began in 2000 and continued into 2007. In the U.S., a partial factor may have been the repeal of Glass-Steagall. More broadly, these mortgage derivatives looked like the new best opportunity for investment growth after the collapse of the NASDAQ. These packages were purchased by banks all over the world, by pension funds, and other financial institutions. The widespread purchase of these investment vehicles by banks and pension funds is what connected home prices in America to financial holdings in Zurich.
As this market grew, there were not enough mortgages being sold to satisfy the demand for the investment vehicles, and this resulted in two things. A new kind of mortgage broker emerged, loaning money for mortgages without keeping the loan on its books. After making the loan, it sold the mortgage to a broker who bundled it with other loans to create packages of securitized mortgages. The payment for these mortgages could then be loaned to the next group. Not to be outdone, traditional banks started selling their loans as well. Those selling mortgages were paid on commission, and were not really “bankers.” Instead of serving the public as a trustworthy financial intermediary, their motivation was to make money by increasing the number of mortgages sold.
Other factors fueled the growth of the sale of mortgages. Interest rates were at an all time low during this period, making a mortgage more attractive. Low interest rates also closed out traditional savings options as a way to grow retirement funds.
To meet the investment demand for more mortgages, new types of loans were created to attract more “home buyers” who may not have qualified for a loan under the old arrangements. ARMs (adjustable rate mortgages) became one of these instruments, allowing very low interest rates at the beginning (sometimes as low as 3%) with the stipulation they would rise to something higher (say 10%) in five years. They even came with no initial payment, since the lender knew this would attract more buyers and they would minimize their risk by selling the loan anyway. Since the buyers believed they could re-sell at a profit before that time, they thought they were limiting their risk as well. And if the buyer actually lived in the home, then they thought they could simply refinance before the higher rate kicked in. More and more people entered the home market because of these favorable terms. But still there was a demand for more mortgages.
Fewer and fewer borrower qualifications were checked, since the market became obsessed with the growth of sales. Some loans required interest-only payments, with nothing paid toward principal over the first few years. Some reduced even this, resulting in growth of the principal. Loans were made with no paperwork, merely the borrowers’ verbal assurance of his or her earnings. Not surprisingly, these became known as “liars loans,” and “subprime” loans were made to buyers who would otherwise not have been considered qualified.
Assessors, supported by lending institutions, were encouraged to raise the valuation of homes, allowing larger and larger mortgages. Contractors were motivated to build more and more homes since the demand seemed insatiable. Rating agencies placed AAA ratings on CDOs made up of pieces of bad mortgages.
Abuses also abounded on the buyer side. Speculators in New York purchased condos in Florida sight unseen, multiples at one time, with the intent of “flipping” them to make money. Poor people bought homes they could not afford (one migrant worker earning $20,000 per year bought a home valued at $1.8 million, according to Michael Lewis in The Big Short).
Not surprisingly, this practice was unsustainable. As things began to crash, innocent and many not-so-innocent people got hurt. Home prices went into sharp decline in 2007, and the packages sold around the world started to fail. Highly-leveraged banks and pension funds that owned them began to crumble. Owners who were stuck with multiple houses and condos were defaulting. Adjustable rate mortgages moved up and people could neither refinance nor sell their homes. When the market stopped buying the mortgage packages, many lenders were stuck with unreasonable and uncollectable mortgages on their books. The resulting lack of available capital and the losses for banks forced businesses to lay off workers or close altogether. Those who had bet that prices would always rise were caught and punished by the market. Home builders, mortgage brokers, and banks went out of business. Washington Mutual became the largest bank failure in U.S. history, having built its strategy on vastly increasing its position in subprime loans; the Federal Depositors Insurance Corporation filed suit (and lost) against its top officers for reckless leadership. Other long-standing investment firms like Merrill Lynch and Lehman Brothers were bought for pennies on the dollar with the government’s help. Meanwhile, unemployment on Main Street peaked at 10.2% in the U.S. with similar numbers in many parts of the world.
Assessing the risk of a total financial collapse, many world governments insured bank deposits, leading to deep government debt. The U.S. government put money into automakers, banks, and other institutions to keep them viable, fearing a much broader collapse.
Innocent parties were also hurt. Banks that never entered the subprime business and held the mortgages they made found that many people owning homes could no longer make payments when owners lost their jobs. Unable to sell the homes which had dropped in value below the amount of the loan, owners walked away and left the bank holding a mortgage for more than the asset was worth. Those who were duped into buying something more expensive than they could afford lost whatever they had put into the mortgage and were forced out of their homes.
Some not-so-innocent parties prospered in this mess. Investment banks which had bought and sold toxic packages of bad mortgages sometimes bet against them as well, hedging their own liability while simultaneously promoting the value of the assets. And in the wake of the crisis, new exploiters emerged. Agents purporting to help those in need sometimes merely took money with the promise of helping cash-strapped households get out of debt, but did nothing. As in other crises, some stepped in to help, and some stepped in to exploit.
In the aftermath of these events, governments acting to help were punished at the polls. The government of Ireland was toppled early in 2011; Democrats lost their majority in the U.S. Congress; many states in the U.S. are deeply in debt; Greece, Portugal, and other countries need varying degrees of rescue from financial collapse. The crisis has gone deep and wide.
Part 2 - "Who is to blame?"
Al Erisman is Executive in Residence at Seattle Pacific University.