An emphasis on short-term performance does not always produce a long-term viable strategy. That looks obvious enough when typed out. But short-termism has become the prevailing logic of many American institutions, none more radically than those institutions that make up its financial sector. As Sheila Bair noted in an op-ed on her last day as chairman of the FDIC, our media, political institutions, and businesses fall victim to this tendency, and it has begun to undermine our long-term stability.
To persist in acting this way would require a kind of insane faith that what’s good for now is good for tomorrow. It’s the story of how every tragedy of the commons ends badly. These attitudes, however, persist less because of any rational deliberation than because institutions can easily devolve toward incentives that reward short-term results.
One principal reason for this is that short-term strategies have a tendency to spread. In a way, this might even be a more general feature of unrestrained competition. I want to make a slightly tenuous comparison to evolution before returning to the more general point.
Assume there is a small plot of land with two unrelated breeds of plant. If plant A can absorb soil nutrients faster and outbreed plant B, it will proliferate and might eventually displace plant A entirely. This is known as exploitation competition. The evolutionary pressures on A become: 1) either depend on fewer nutrients, 2) develop a some alternate replication strategy, or 3) simply beat B at its own game, by reproducing faster and extracting nutrients more quickly. The last of these is the one I want to emphasize: Short-termism is self-reinforcing and it is contagious. When B’s reproductive strategy is on short-term success, it redefines the game for A. Eventually it becomes the only game left. This is what kudzu did when introduced in the southeastern United States. Taken to an extreme, quite literally, this is the logic of cancer.
In other words, if B chooses to play a shorter-term game than A, that redefines the game A must play to survive. Market competition is also susceptible to this dynamic, and in many ways it may account for some of markets’ successes. The process can weed out under-performers and produce more efficient manufacturing processes. But it also weeds out other business models that under other conditions would be perfectly viable and sustaining.
This fact alone should also provide a compelling reason for market regulations—something I’ll write about another time—but this dynamic also means the following: If a business starts engaging in rent-seeking activities (i.e. attempting to influence government into creating a legislative or regulatory playing-field more favorable to its interests), then quickly other competitors, other businesses, and even entire sectors may be forced to follow suit.
To make the link now to the financial sector: Incentives in the financial community have become tied closer than ever to short-term performance. Such incentives have the potential to reward speculation, and the 2008 crisis revealed that these incentives have the potential to reinforce bubble-generation. Extreme short-termism redefined the terms of competition. It drove firms that emphasized longer-term performance and responsible practices to obscurity and irrelevance, and it drove many organizations into riskier positions to remain competitive (e.g. the decision at Fannie Mae to get into subprime mortgages in 2007). It should not be surprising that given the ways that incentives were linked to performance that the terms of competition became what they did.
Nor is it surprising, as Bair notes, that short-termism has come to characterize many of Wall Street’s interactions with Congress and other regulators. Rent-seeking through lobbying and other activities directed toward obtaining a favorable regulatory playing-field have now become part of the ways that businesses in America compete. To take one easy example, provisions of Dodd-Frank that were seen as restraints on business were cut, watered down, and those that were left in have been implemented half-heartedly. And that happened despite a general consensus that Dodd-Frank was not aggressive enough in providing the US the framework it would need to respond to another financial crisis.
[Legislators are now plagued by a similar dynamic of having to fund-raise to keep up with each other, with a short-term focus on reelection rather than on governance. This further exacerbates the influence Wall Street spending can have].
Given the various ways in which Wall Street successfully defeated attempts to impose new regulations after the 2008 crisis, we would expect that the financial sector would be well-positioned for the coming decade or to handle another crisis. But this hardly seems to be the case. The shadow banking system, probably the single largest accelerator of the crisis’ spread remains largely unregulated. Banks are fighting tooth and nail against hightened capital requirements. And the fact that large financial institutions pushing for austerity measures is so shorted-sighted as to ignore any possible interdependence between growth and a healthy middle class. Etc. etc.
Perhaps the most insane thing about all of this is that large financial institutions and proponents of deregulation are so short-sighted that they believe this kind of game is actually serving their interests. [Or maybe the game is just to be the last one standing?]
To quote a post at Digby’s blog about Murduch’s ability to rapidly corrupt the WSJ, one of the world’s “most important sources of financial news”:
I think this may be the best sign yet of just how crippled our institutions have become. If there is one group in the world who should demand unadulterated facts and data it is the financial community. Sure, they’ll play it to their advantage, and care not a whit about how it affects our democracy. That’s not their job (although it is their duty as citizens.) But they simply cannot function properly if their information is tainted.
The ‘invisible hand’ produces races to the bottom just as often as it produces self-regulating systems. We have failed utterly to keep the terms of this game from keeping this short-term contagion in check. When that happens, even the winners are at risk.
Photo credit: Galen Parks Smith.