Externalizing the Risk

The formula for maximizing margin is to minimize the risk to that margin.

As an economy consolidates into economies of scale to reduce the alpha risk, the risk accumulates into beta and gamma risk. Since the risk has been detached from the alpha fundament, and it has to go somewhere, the formula for maximizing margin then becomes: internalize the profit and externalize the risk. The result is the economic condition we are in now with large, consolidated corporates accumulating profit and distributing the risk.

Profit is detached from the risk, increasing the marginal profit. The risk is transformed, not reduced, and redistributed without the profit. The risk is transformed into crises that cyclically occur at a depth and frequency of the distribution. Currently, the risk has become so external to the profit we now see the prospect of a lengthy recession and a possible double dip with the threat of deflation.

When the profit does not distribute with the risk, gamma risk accumulates and crisis will occur.

In the form of alpha risk, profit distributes with the risk, providing a disinflationary, distributive, pluralistic benefit to the market.

Accumulation of value, on the other hand, like we see with an economy-of-scale efficiency, provides a non-distributive, non-pluralistic, inflationary benefit (the marginal profit). The accumulated benefit harbors the risk of deflation--negative growth, unemployment and declining prices (general economic crisis that causes the need for authoritarian management of the risk, or The Iron Law of Oligarchy and emergence of The Iron Triangle form of government).

By ensuring an alpha-risk distribution, pursuit of profit not only externalizes as reciprocal value, providing goods and services with good and adequate consideration, but also imparts a distributive value that stabilizes prices with adequate, disinflationary liquidity. The result is positive growth with declining unemployment, debt reduction, and reduction of systemic risk at the unaccumulated fundament.

Alpha management of accumulated (externalized) gamma risk is a strategy that could have been easily employed by the Obama Administration and a Democratic congress.

Instead, the government (The Iron Triangle) engaged an inflationary risk-management program (described as "Keynesian") that has kept the risk external to the profit (thus, the bull market up to now, and the false signal of being descriptively pro-growth).

A top-down, trickle-down Hamiltonian model is to command and control systemic-risk (business cycle volatility), not reduce it.

Employed by the Obama administration and Congress, the Hamiltonian model of finance has supported a recessionary trend and increases the probability of a deflationary dip (lack of demand to support growth). Instead of alpha-risk stability, they achieved beta-risk volatility--exactly what we do not need.

In the alpha form, risk to the profit margin inherently distributes with the benefit. The margin is then at verifiable risk, accountable, to the free choice of market participants. When that choice is minimized by organized consolidation, internalizing the profit by externalizing the risk, the risk goes gamma.

With organized consolidation of the risk, managed in the aggregate (externalized) independant of the profit margin, the present value of the risk goes beta. Its marginal value becomes more dependant on political sentiment. It is more difficult to measure and, with a more uncertain future value, more volatile.

A speculative market (regulatory arbitrage) then emerges to command and control the gamma risk, and the beta volatility, in the guise of reducing it.

The bureaucratic model of power and political economy emerges (The Iron Triangle) to conserve the distributive value of the Hamiltonian model. This neo-conservative, post-industrial innovation of the model, especially after the Great Depression, provides "the risk" with a predictable presence of value.

The purpose of the neo-conservative model is to phenomenologize a legitimacy of internalized risk. It is a false legitimacy with power literally being a top-down "derivative."

The risk to gaining power and keeping it is not a pluralistic ontology, like a free-market legitimacy, derived from the bottom up. It is being imposed from the top down.

Alpha-risk modeling that ensures a free-market mechanism is what genuinely internalizes "the risk" so we are not slaves to the Iron Law.

Conserving the Value of the Risk

Pending financial reform will conserve the present value of the risk in a fractile, chaotic oscillation.

In order to forge order from the chaos, fitting the assumptions of the Hamiltonian model, the fractile dynamic demands an economy-of-scale efficiency. Reform is designed to conserve a financial system with an efficiency for "making markets" to command the risk.

According to lawmakers and the executive, the reform provides protection for everybody. Main Street is protected from Wall Street, and Wall Street is protected from Main Street.

It is assumed that as long as the risk of systemic failure can be controlled, big financial firms will "make the market" so that the consolidation of risk has useful value other than generating profit without growth--the source of the risk.

The reform does not consider hedge-funds and private equity firms a source of systemic risk, but a source of disinflationary capital, providing financing for small businesses.

The assessement is entirely incorrect. Reform, however, protects tax breaks for hedge-funds and private equity, for example, that do most of their business with Goldman Sachs, and will surely cultivate the next crisis reformers correctly predict, but incorrectly support.

Since pro-growth capital is not likely, having no mandate because the risk of failure will supposedly prevent overleveraging, the reform provides a fail-safe mechanism to protect the public from overaccumulated amounts of leveraged risk. At the same time, the accumulated reward of the risk is protected from the accrued retributive value, conserving the value of the risk.

As financial reform nears reconciliation, support for financial equities supports the hypothesis of conserved risk value.

It was an easy call, clearly indicated by an unwillingness to disaggregate the risk. Instead, reform measures will consolidate financial markets further
in the event of an overleveraged crisis of fractile risk that the Senate Banking Committee chairman says will surely happen.

Despite reform that calls for the orderly resolution of fractile risk, the causal factors of accumulated risk are conserved and supported by the resolution authority, which is exacly what we do not need.

The reform buys-in to the use-value of conserving the risk and the too-big-to-fail organizations that both create the risk and value the presence of the risk into a fractile, chaotic volatility. As the risk compounds and accumulates into a crisis proportion, the technical expertise of big-bank executives and staff that get it there will then resolve the risk and consolidate it into a bigger, too-big-to-fail economy of scale. It is the problem offered as the solution and, again, an easy call.

Despite the authority reform will endow to resolve firms that overleverage the capital into crisis, the cost of unemployment, for example, and lost productivity is not included in the concept of not providing a bailout. These costs are just as much a bailout for too-big-to-fail firms because they benefit from it in addition to the big profits made causing them. The value of the "big risk" is every bit conserved.

Investors can expect the risk differentials to be essentially the same. The daily narrative of present value will set up sudden inversions that require a close monitor of massive accumulation and distribution of capital that manipulate future value with an aversive sentiment.

The reform is not risk averse. It is risk prone, which drives market sentiment into sudden and salient oscillations of greed and fear that support the profitability of too-big-to-fail financial firms, hedge-funds, and private equity adjuncts.

Unfortunately, financial reform will give the problem to be solved the legitimacy of deliberative public process toward securing the general welfare. It will force us into adverse choices that economies of scale bundle (oligopolize) into what only appear to be a bargain in the absence of a free-market, alpha-risk ontology.