The Price of Clarity

“Through the contrivance and cunning of stock jobbers there hath been brought in such a complication of knavery and cozenage, such a mystery of iniquity, and such an unintelligible jargon of terms to involve it in, as were never known in any other age or country.”

“Through the contrivance and cunning of stock jobbers there hath been brought in such a complication of knavery and cozenage, such a mystery of iniquity, and such an unintelligible jargon of terms to involve it in, as were never known in any other age or country.”

Jonathan Swift’s eighteenth-century barb resonates in today’s world of financial “intermediation”: now, as then, finance shrouds its “complication of knavery and cozenage” in “unintelligible jargon.”

As US President Barack Obama explained in a speech in April: “Many practices were so opaque and complex that few within these companies – let alone those charged with oversight – were fully aware of the massive wagers being made.”

But was Swift right to see knavery as the main motive for unintelligibility? Obviously, it is a very powerful motive, in politics no less than in finance. The less people understand about something, the easier it is to fool them.

There has never been a shortage of snake-oil merchants: Donizetti wrote an opera, L’Elisir D’Amore, about one of them advertising a love potion in a nonsensical patter. But the intention to deceive, or even to make money, is not necessarily what has driven the recent explosion of financial innovation.

Consider the US Securities and Exchange Commission’s current civil suit against Goldman Sachs. Goldman whiz-kid Fabrice Tourre is charged with having created a complicated security that was designed to fail.

Was his intention to deceive? Or was it the intellectual pleasure he got from creating a “Frankenstein monster” (as one of his e-mails described it), regardless of the consequences?

The latter seems the dominant motive. As another of his e-mails put it:  “The entire system is about to crumble any moment...the only potential survivor the fabulous Fab...standing in the middle of all these complex, highly levered, exotic trades he created.”

To be cleverer than the pack (and of course making money by his cleverness) seems to have been Tourre’s driving passion.

Finance has always been opaque, quite apart from the motive of swindling the investing public. “Double-entry bookkeeping” is one of the great discoveries of European civilization, but five centuries later most people are still muddled about assets and liabilities.

Without such knowledge, technical terms like “balance-sheet recession” and “rebuilding balance sheets” are meaningless.

Opacity has grown with complexity. The explosion of derivative instruments has demanded such an effort at understanding that metaphorical language is needed.

Think of collateral debt obligations (CDOs) as poisoned sausages, says the economist Nouriel Roubini, with sub-prime mortgages as the rat meat in them. With a mental effort, the layperson can then imagine these poisonous sausages, otherwise known as “toxic assets,” spreading through the world’s banks, ruining their digestions and crippling the economies they are meant to serve.

But complexity is not the only reason for obscurity. In his famous essay “Politics and the English Language,” George Orwell pointed to the widespread use of euphemism, which means not calling a spade a spade.

This, he thought, was due to too many facts in the modern world having become too horrible, or unpalatable, to be stated clearly. One of his examples was the phrase “rectification of frontiers” to sugar-coat forced population movements.

Political correctness is another aspect of this: calling disabled people “differently abled,” for example. As the historian Tony Judt points out: “It’s not a ‘different’ ability, it’s no ability. Lousy language...conceals the effects of real power and capacity, real wealth and influences.” It enables deep inequality to happen more easily.

As important is a straightforward decline in literacy. Orwell talked of officials putting together blocks of words like “prefabricated hen houses.” This quality is much in evidence in a recent IMF report:

“Risks to global financial stability have eased as the economic recovery has gained steam, but concerns about advanced country sovereign risks could undermine gains and prolong the collapse of credit.

Without more fully restoring the health of financial and household balance sheets, a worsening of public debt sustainability could be transmitted back to banking system or across borders.

Hence, policies are needed to (1) reduce sovereign vulnerabilities, including through communicating credible medium-term fiscal consolidation plans; (2) ensure that the ongoing deleveraging process unfolds smoothly; and (3) decisively move forward to complete the regulatory agenda so as to move to a safer, more resilient, and dynamic global financial system.

For emerging market countries, where the surge in capital inflows has led to fears of inflation and asset price bubbles, a pragmatic approach using a combination of macroeconomic and prudential financial policies is available.”

Ironically, the same document is full of demands for greater “transparency.” So let us translate that IMF passage into transparent English:

“The world economy has become less risky as it has recovered from recession, and as banks and households have reduced their debts. But fears of government default in rich countries could threaten the recovery by causing interest rates to rise and exchange rates to fall.

So three things are needed: governments must (1) cut their deficits gradually in a believable way, (2) keep enough spending going to compensate for increased saving in the private sector, and (3) press on with bank regulation. For developing countries, economic policy and bank regulation should be used together to stop inflation and asset bubbles.”

The greater the distance between the language of elites and ordinary people, the greater the risk of revolt. To the extent that complexity in finance or politics creates new opportunities to deceive, impedes understanding, or blurs lines of accountability, we should aim to reduce it.

To the extent that such problems reflect decreased ability to express oneself clearly, the remedy is to improve education. The price of clarity, like the price of liberty, is eternal vigilance, and the two are connected.

Robert Skidelsky, a member of the British House of Lords

Copyright: Project Syndicate, 2010.


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