Cyreenik Says
Bubbles and Busts when viewed from the Prisoner's Dilemma perspective
We are experiencing interesting times.
We are experiencing The Incredible Growing Financial Crisis.
We throw... not billions... not tens of billions, but a trillion dollars at the problem, and it just won't stop growing!
What's going on here? Why won't this problem go away quickly?
This is a classic bubble burst... albeit a big one... but what does that mean?
Lets look at bubbles and bubble bursting from the Prisoner's Dilemma point of view.
As many commentors on this crisis have pointed out: banking is a business of trust. And the government is throwing money at the problem to build trust.
From the Prisoner's Dilemma perspective, what does that mean?
It means that people have been operating in a double cooperator environment. It means that people have not been dealing at "arms length" -- if the right person said, "Trust me. This is a good buy." The the person listening did... without doing enough further checking.
Double cooperator environments are good for many reasons. First, they are efficient -- the time and money that goes into protecting against a potential defection isn't spent. Second, they feel good. It always feels nice to do profitable business with someone you can trust. Third, the agreements tend to be informal, so they can adapt quickly to changing circumstances.
If they are so good, why don't we do all our transactions in a double cooperator environment?
Because there is always the potential for one party or the other to defect -- to not do what they promised. When that happens, the "loser" (the one who didn't defect) suffers greatly. He or she suffers physical loss, and they suffer embarrassement for trusting the defector. "How could you trust him!!" friends and neighbors will ask, then shake their heads.
So, double cooperator environments take time to build -- they come with trust. When a businessperson talks to another businessperson saying something like, "We want to build a long-term relation." the talker is saying he or she wants to build some kind of double cooperator relation.
Bubbles are a time and place when there is a lot of double cooperator business going on, but the business is built on a shaky foundation. Bubbles can start for many reasons, but two of the most common ingredients are:
a) a new legal or technological opportunity opens up
b) this new opportunity gets exploited in a double cooperator fashion.
When novelty and trust are making an industry grow, this is the foundation for a bubble.
The bubble burst comes when too much defection happens. When there is too much defection, some bubble participants feel betrayed, and their neighbors who are also playing the bubble worry that they will be next. The trust turns to worry about betrayal, and the environment "snaps" out of double cooperator mode. This what has been happening to the world economy over the last two years -- there have been a series of "snaps" as new financial weaknesses are steadily uncovered.
The technological or legal opportunity that started the bubble was the combination of the US government encouraging more home ownership in various ways and the financial industry inventing a new way to sell more easily the new mortgages that came with more home ownership. This confluence of feel good community interest and financial inventiveness began in the mid-90's, and grew and grew.
The key to all this working was steadily rising home prices. But as the business relations making money on this bubble grew into years-long relations, they became more double cooperator, more trust-oriented. The participants would think, "You're making money. I'm making money... Yeah, lets this is again... and bigger!" And they ignored how important steadily rising home prices were to the equation.
This evolution into double cooperator meant that when the party ended, it was going to end with a bad hangover. There was going to be defection, and there were going to be badly upset people... people who felt betrayed.
We have that... and we now have people who are watching this betrayal evolve who feel scared. The scared ones think, "Is this situation going to happen to me?"
What comes after the bubble is normalizing the relations that created the opportunity in the first place.
Sadly, this means no more special opportunity to exploit, and no double cooperator environment to exploit it in. It means the bubble is broken and the good old days are not coming back. Some more formal system of doing buisiness will be set up in place of the old double cooperator systems. Formal in this case means a double defector system where all parties are protected, but the cost of doing the business will rise -- rise in the sense of limited opportunity, and more cost and time to do transactions.
Those who made money on the old system will sigh and long for the good old days. Those who got betrayed in the bubble burst won't miss a thing... except their hard-earned cash which vaporized as their hot market vanished.
That's what I have for November in Cyreenik Says.
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