One argument that Kudlow and friends make is that executive bonuses are needed to retain talent in the financial system at a time when it is needed the most. It is this particular argument that interests me the most. I want to examine that statement from first principles, because I believe that some simple, plain thinking on this particular issue will bring clarity to the broader debate about the financial crisis and what is to be done about it.

That statement about bonuses is interesting because it rests on a stack of assumptions, at least five tortoises deep. They in turn are interesting because they are mostly unspoken and unexamined. So even listing them out is a learning exercise, because we are bringing something hidden out into the light.

So here they are, starting from the top tortoise:

1)   bonuses attract talented people

2)   running a finance company requires talent

3)   a finance company’s performance depends on the people who run it

4)   the financial system responds to and rewards human intervention

5)   the financial system is controllable and non-random

I’ll come out and say it: my contention is that all of these assumptions are wrong. Because each tortoise stands on the other’s back, it really only means that the most basic assumption that is at the bottom of the tower is wrong – if you can turn him over, all the others will topple. But I’d like to start from the top, because each of these assumptions reveals something about the way we have been trained to think about risk, control and the institutions that often run our lives.

Tortoise number one is easy enough. Bonuses attract people who are talented at making bonuses. If bonuses are offered routinely, without regard to actual performance, then the only talent you are selecting for is the desire to make money through a bonus. When you can get big bonuses even if the company is doing badly, then you are probably selecting for people who want to make money and are particularly shameless about having it delinked from performance. Which is pretty much what has happened – AIG being only the latest float in this sad parade.

Which brings us to tortoise number two – does it even matter who runs a finance company? If the best and brightest really were running AIG and others, why have they all failed at once? Nassim Nicholas Taleb has talked about replacing stockbrokers with random number generators and replicating their performance. A similar experiment with finance companies has never actually been performed, but we can do it as a Einstein-esque “thought experiment”. AIG, Freddie Mac, Bear Stearns – all being run by a two line computer program. Every decision, no matter how big or small, being made by an electronic version of a coin toss. What would happen?

I would say they would compare quite well. They might not have avoided a financial crisis, these little computer-virus-executives, but would they have done worse? Worse than losing a trillion dollars* and destabilizing the entire system to the point of collapse? I really don’t see how they could have. Trading versions of our imaginary executive cabal (with the addition of a chimpanzee) have out-traded the best of Wall Street. In analogy, at least, we could say that our computer programs would not have under-performed our real, flesh-and–blood finance executive class over the last year.

But in the interests of rigour, let’s say that we can leave this tortoise half-toppled, on his side. This issue really is  intertwined with our next assumption, and they stand or fall together.

The question is can a finance company be “run” at all, the same way that other companies can be run? I say not. Finance companies depend on the ability to predict the future, much more than real companies. Their health depends directly on the state of the sharemarket. And as the events of the last year have shown, no one can predict the sharemarket at all. So, as an executive of a finance company, you are in the position of a gambler at the roulette wheel. We don’t say that gamblers are “running” their casino campaigns, and neither are the finance executives running their companies. They can choose where to put their chips, but I would say we need to use different language to describe that level of control. 

We are approaching the real issue, the grand-daddy tortoise at the bottom of the stack. I’d like to stick with the casino analogy, and take it through to the end. The point about a casino is that it is a well-marked, separate domain which we understand as being completely artificial. Casinos play games with people’s money. For some reason, we don’t think of the financial system in that way – it is supposed to be far less arbitrary. But it is not. The random stochastic process that drops a roulette ball into a particular slot has its analogy in the financial world as the output of an immensely complex, chaotic system known as the sharemarket. I won’t tour the mathematics here, but essentially the output of a chaotic system is as random and unknowable to the observer as a “real” random process. Next year’s share price is as likely to go up as a bet on red.

So what about our second-last tortoise, the one about human intervention? Human intervention counts for approximately nothing . Humans in casinos are only there to deal the cards and serve the drinks. The results of the games don’t depend on the humans. They make decisions and may have the illusion of control, but there is no such thing as a skilled gambler – only lucky ones.

Just a side-point about the “artificiality” of finance. I believe that the finance world may have exacerbated the inherent problems of a chaotic system by creating an elaborate, artificial super-structure on top. The weird and wonderful financial “products” that preceded the crash – such as derivatives, futures, credit swaps and the like – have all the ingenuity in design of casino games; they were mostly constructed to hide the nature of the underlying system and mask the real nature of the risk. Of course, they enriched their architects, which is why they were created in the first place. Modern finance is an artificial industry. Finance companies produce nothing real; they use money to make money. They know it themselves, which is why they try the sleight-of-hand of labelling their schemes as “financial products” to make them seem more concrete. Finance is entirely man-made with no connection to nature. There is nothing wrong with that in principle, but people do not recognize its artificiality. They think of finance as just another industry, as real as building or education or medicine. But it is fundamentally different, because it is not organically connected to reality - and by treating it as if it is, we have made a grave error.

The fattest tortoise is on its back, and we can work our way back up and watch them fall. The financial system is chaotic-random and not controllable. No one can predict the future of the market and no one can “analyze” the system beyond recognizing that it is chaotic. People created the system but are now at the mercy of it. On a small-scale, human intervention can have some local effects, but over time scales of interest their contributions do not bring any patterns to bear. Finance executives might as well play solitaire, and do less harm. In the big picture, their companies "run" themselves. No one “surfs the waves in” – everyone is a just a cork bobbing around. Not only does a finance executive not require talent, but talent is irrelevant. And paying bonuses that are delinked from performance simply adds another layer of stupidity on top of the dung-heap by selecting an executive class that is especially indifferent to the idea that money should come from work.

Can we spy an even plumper tortoise at the bottom of the stack? If the sharemarket - and its dependent systems - are a thrashing, chaotic double-pendulum, why have we based a civilization around it? Perhaps the world would be better off without a financial industry as we know it. I can hear Kudlow and friends gnash their teeth – Commie bastard! But this is not a Marxist critique. It is only this particular model of capitalism, with a casino as its engine room, that is on the nose. Maybe we can buy and sell real things and work for each other quite well without the sharemarket. In fact, if real capitalism is about private enterprise, then why shouldn’t my little going concern be unshackled from this complex, unpredictable beast? A little bit of credit, money in the bank, no usury and a system that rewards work. As one of my university professors used to say, just some “common-f***ing-sense”. How did we get to the point where that seems radical?

*That is my estimate. No one knows the actual figure, and it doesn’t make a difference to the argument