Saturday, October 23, 2010

A Fingerprint of Instability in Biology and Finance

      Recently, there has been much research into the chaotic dynamics of complex systems in many different fields. Complexity theory provides great analytical insights into the structures of "hard" sciences such as biology and also social sciences such as economics. It can even reveal dyamic properties that will serve as predictive indicators across both of the two fields (and perhaps many others). It should be noted that "predictive" doesn't necessarily mean a specific result will always follow, but that it becomes significantly more likely to occur. The following article will explore a relatively simple indicator which identifies high probabilities of instability in both the human circulatory system (specifically cardiac) and financial markets. Let's start this discussion with a short quiz. Take a look at the following four graphs of heartbeats per minute over a 30-minute interval, and see if you can guess which one(s) belongs to a healthy patient and which one belongs to a patient facing sudden cardiac death:


      Many people would presume the first graph belonged to a patient with severe heart problems, but they would be incorrect. In fact, the first one is that of a healthy person at sea level, the second of a healthy person at high altitude, the third of a person with obstructive sleep apnia and the fourth of a person with ventricular fibrillation. [1]. The key observation here is that the variability of time intervals between heartbeats decreases as the subject's cardiac and respiratory functions become more unstable. Variability is not the same as randomness, however, and is actually the product of an underlying complex mathematical structure. We can describe it as "deterministic chaos", where the initial conditions of the sympathetic and parasympathetic nervous systems (influenced by thermo-regulation, hormones, sleep-wake cycles, meals, stress, etc.) [2] give rise to beat time intervals that are locally unpredictable, but exhibit a globally identifiable pattern. It is the intricate "music" that results from a complex orchestra of underlying instruments and notes, rather than the "noise" which would result from random tones. [3].

      The time series of a healthy human heartbeat is a fractal structure, since it is an irregular pattern with fractional dimensions that exhibits "self-similarity" at different scales of resolution. We observe fractal structures in many different natural systems, whether it be a continental coast line, branching tree, human circulatory system or even impulses generated from biological processes. The fractal structures that arise from processes of the heart dynamically interact with all other rhythms of the body and help maintain a stable lifeform. Although these rhythms each exhibit a deterministic variability of their own, they also synchronize with each other so that different parts of the body can work together while staying within a bounded range of operation. An unhealthy human heart, on the other hand, is characterized by a collapse of inter-communication with other signals and a return to a regular, intrinsic rhythm that has lost its emergent order. [4].

Fractal Coastline
Fractal Blood Vessels


Fractal Tree

     It is important to understand that complex dynamics leading to emergent order may also endogenously lead to instability and collapse. Human beings with healthy hearts may be able to perform many activities within a given day. Perhaps some of those activities and interactions will lead to significant amounts of stress, which negatively influences the peoples' eating and/or exercise habits. As their circulatory system becomes less efficient, they require more energy to simply maintain the level of activity they have become accustomed to. The people turn to more food and/or other substances to acquire this energy, and eventually they are caught in a destructive cycle which undermines the heart's stability. Of course, this example is just one potential nonlinear path of cardiac evolution, and there are obviously many examples of people maintaining relatively healthy hearts for much of their lives. This endogenous emergence of fragility is much more frequent and evident in complex financial markets where, as Hyman Minsky would say, stability breeds instability. [5].

    Didier Sornette produced an excellent report in 2002 entitled Critical Market Crashes [6], analyzing the endogenous patterns that emerge in stock markets before they reach a "critical point" at which a crash is most likely to occur. Most of the report is extremely technical and hard to digest for the average person who is not very familiar with nonlinear statistical mathematics (which certainly includes me!). However, there are a few qualitative points made that are readily accessible to a lay reader. For example, the report shows that asset markets typically crash when "order wins out over disorder", or when the variability of traders' opinions on the future direction of prices decreases to a certain threshold, causing the market to become extremely illiquid. [7, 37]. This dynamic is also the reason why bullish extremes in market sentiment tend to mark a top that will soon be reversed. However, the order that "wins out" in a market crash is a superficial order, rather than the natural order which emerges from the variable behavior of individual agents. The former can be analogized to the regular time intervals between unhealthy heartbeats, while the latter would be the variable intervals which correspond to biological synchronization and stability.

     Sornette also explains that dynamic stock market patterns are characterized by "discrete scale invariance", which is basically another way of saying they are fractal in nature. A typical chart of stock prices over any time frame will produce highly volatile, yet non-random patterns that are self-similar to patterns on shorter or longer time scales. Related to Sornette's work is the "fractal markets hypothesis", which has been explained simply and coherently by the Australian economist Steve Keen in a slide lecture he produced and made available to the public. [8]. To summarize, this hypothesis suggests that the stock market exhibits deterministic chaos, making the short-term movements of prices extremely difficult, if not impossible, to predict. Similar to the healthy human heartbeat, the market achieves aggregate stability when investors have variable time horizons and expectations for their investments. In contrast, a speculative bubble is formed when many investors share the same expectations, imitating each other's decisions to buy, and a market crash occurs when they all "rush for the exit" at the same time. [Slide 36]

     The reason why variability of time horizons is so important for market stability can be explained with a simple example. Let's compare an average day trader with a five-minute time horizon to an institutional investor (such as a pension fund) with a weekly time horizon from 1992-2002. The average five-minute price change in 1992 was -0.000284% (an overall "bear market"), with a standard deviation of 0.05976 per cent. A six standard deviation drop (-.359%) in price during that time period could easily wipe out the day trader's investment if it continues. The institutional investor, on the other hand, would consider that drop a buying opportunity since weekly returns over the ten-year period averaged 0.22% with a standard deviation of 2.39%. The relatively large drop for the day trader is basically a non-event for the weekly trader's technical/fundamental outlook, so the latter can buy the dip and provide stabilizing liquidity to the market. [Slides 38-39]

     As most people in the world of finance know by now, every week in the stock market is characterized by increasingly few actors trading on an increasingly short time scale. Retail investors with relatively long-term time horizons and variable trading preferences have been exiting the market in droves (~$80B equity outflows from domestic mutual funds YTD) [9], while computer-based high frequency traders have dominated the market and buy/sell to each other in time scales best measured by seconds (one of the largest HFT firms, Tradebot, holds stocks for an average of 11 seconds). [10]. A paper by Reginald Smith, from the Bouchet Frankline Institute of Rochester, has confirmed this trend by showing that high frequency trading (HFT) "is having an increasingly large impact on the microstructure of equity trading dynamics". Currently, more than 70% of U.S. equity trading comes in the the high frequency variety. Smith also states that "traded value, and by extension trading volume, fluctuations are starting to show self-similarity at increasingly shorter timescales". [11]. In essence, the robot traders are dominating the market and destroying the natural fluctuations between stocks traded, shares traded, trading volume and time horizons that characterize a "healthy" market.

Top Graph - HFT % of U.S. Equity Market
Bottom Left - Average Trade Size in NYSE
Bottom Right - Average Trade Size in NASDAQ

     Given the above information, one may conclude that we are currently on the verge of the stock market equivalent of "sudden cardiac death", but that's not entirely accurate. Although the dominance of HFT in the market has helped destroy healthy variability, it is not the root cause of systemic instability. That designation is more appropriately reserved for the decades-long credit (complexity) bubble which has ensued all around the world, but especially in the United States. The reality is that the "critical point" for U.S. financial markets was already reached in 2008, and as most Americans are aware, the markets almost died back then. Cue the federal government and federal reserve, which provided trillions in "liquidity" to artificially create the variability that had been lost. The politicians and central bankers would like to think of themselves as the defibrilator that has sparked the financial "heart" back into a healthy rhythm. However, that analogy is simply not accurate, as evidenced by the current equity market's painfully boring microstructure. They are more like the artificial respirator that is keeping the brain-dead markets "technically" alive. Their tireless efforts are simply masking the terminal reality that lies underneath, and now we're all just waiting for someone or something to finally pull the plug. 

Monday, October 18, 2010

Fear & Loathing in the Divided States of America

The late, great Hunter S. Thompson captured the current sentiment of American society best when he wrote the following words 40 years ago, in his book Fear & Loathing in Las Vegas [1]:
"You can turn your back on a person, but you can never turn your back on a drug, especially when it's waving a razor sharp hunting knife in your eye."

      America has defined itself as a society of collective "drug people", pushers, addicts and associates, with our drug of choice being debt. We happily injected drugs worth 300% of our GDP straight into our veins, and made our international dealers filthy rich in the process. The constant influx of drugs into our bodies made us feel super-human, as we were instantaneously able to afford TVs, computers, cars and homes with the swipe of a card and the flick of a pen. Of course, as any regular drug user can attest, the human biological system becomes increasingly tolerant to the jolts of external chemicals and requires ever-larger doses to achieve the same effects. The economy rapidly became saturated with debt, since economic actors needed to take on more and more debt to simply pay off previous debts and maintain their current level of activity. In 2007-08, the private debt servicing costs overwhelmed the "high" produced from this mostly unproductive debt, in the form of artificially elevated asset prices and revenue streams, and the national body had no more financial capacity to absorb additional drugs. With no more access to their drug of choice after a decades-long binge, the addicts began going through severe withdrawal. The drug-induced mentality of happiness, trust and tolerance was quickly replaced with collective feelings of sickness, fear and resentment.

      Individual people who constantly abuse drugs face a deck deeply stacked against their survival and/or  a stable existence, but there is always a distinct possibility that they can be "rehabilitated". With some strong support from family and friends, the addict can go into a "program", take the necessary medications, attend the required counseling, learn some discipline and then come out on the other side a healed creature. This recovery is especially likely when the drug consumed is relatively weak, the duration of addiction is relatively short and the addict's community is a strong source of support. The dynamics become significantly less favorable in a society of millions of addicts, all feeding off of each others' addictions and desperation, without many voices of support or reason. In this environment it becomes much easier for addicts to deny that they even have a problem, let alone it needs to be fixed, and the disconnect between fantasy and reality persists despite the symptoms of societal sickness steadily worsening over time. These symptoms grow gradually more influential as the withdrawal continues, and they can also lead to sudden, acute episodes of collective discomfort.

      Many addicts in this situation will simply refuse to face the harsh new reality and continue doing anything they can to find their next fix, especially when there is a friend or family member financially enabling them to get a few more hits from the local dealer. In the wake of peak financial activity in the private sector, the American government popped in and told its citizens "not to worry", because it would provide the temporary subsidies, tax credits or backstops that they needed to get another debt fix. It also whispered to the dealers "not to worry", because it would keep their profitable drug trade going, seeing as how it supported such a significant percentage of the economy and the past promises made to a now restive population. American addicts continued a sporadic debt binge for some time, but on the whole they continued to be priced out of the saturated market. The struggling addicts eventually have to start fending for themselves, as the  government's income is increasingly consumed by direct or indirect handouts, and it transforms into the "friend" who is giving up on the incorrigible addict. What's left is a society of fiendish, debt-starved addicts who, with increasingly little to lose, project their misfortunes onto others.

      There is very little room for trust in the minds of addicts, since they feel betrayed in some way by all of the people who surround them. The addicts will simultaneously fear and resent dealers, friends, family, authority figures or even strangers, because these are the people who have exploited them, enabled them, ostracized them or are competing with them for survival.  A drug dealer can be the addict's knight in shining armor when times are good and highs are cheap, but rotten crooks when the supply runs out and the sickness sets in. American individuals and small businesses now find themselves in the schizophrenic split-state of both depending on debt pushers to continue financing routine activities, and hating them for privatizing the gains of their drug trade, socializing the losses and continuing to operate in what appears to be good health. It is unsurprising that more than twice as many debt addicts blame their creditors (51%) for the latest financial crisis than themselves (24%). [2]. However, drug users typically hesitate to confront their dealers in any significant way because they respect the money, power and influence wielded by these dealers. They can cut off users' supply to more drugs or even harm/kill them or their families if they really start acting up. Major American banks may not execute their customers and their families, but they can certainly cut off access to additional debt or refuse to negotiate with struggling debtors and repossess much of their secured property. When the powerful dealers are largely untouchable, much of an addict's residual loathing is focused on the system at large and those who manage it.

     Drug users typically acquire their destructive habits at an early age, aided in no small part by the central institutions they have relied on, such as their household, community, school or government. Once the joyous journey of drug-filled exploits has run its course, addicts are left with an empty life within a pitiless system. The American journey has been characterized by a federal government and central bank which has stopped at nothing to encourage the debt addictions of their citizens, all the while insinuating that the drugs were necessary for a normal and successful existence. Americans took this propaganda to heart, and now that the debt drugs have run out, they are actually left with the opposite of what they were promised. The "tea party" movement epitomizes a strung-out population of addicts who have grown extremely tired of all the lies and unfulfilled promises, and are enraged at those who have so casually fueled their destructive habits for years on end. This movement has correctly identified the central government as a corrupt institution which puts on a public face of sympathy and compassion for the American addicts, while secretly dividing up the profits of the drug trade with dealers instead. Of course, the hellish fury of an addict scorned can express itself in many ways.

     Some of the debt addicts get together in meetings and communicate their hatred of the "big, betraying brother" who constantly looms over them. They carry signs filled with anger, make rapacious rants or generally protest the fact that their share of the drugs is being diverted to others, but their unrest is mitigated by lingering flashbacks to a previous state of debt intoxication. Other addicts have realized that they can talk all day and never secure any more drugs or become healthy, so they attempt to join the dealer complex, where they will bring down the destructive debt trade from the inside and liberate their fellow addicts from the sickness. Sadly, when these addicts successfully make the transition from the world of users to the world of dealers, they usually forget all about the plight of the addicted and sell out for a share of the profits. A few addicts eventually hit rock bottom, and give up all hope on a return to normalcy or a bearable existence. One such American addict decided that instead of protesting or running for political office, he would get behind the controls of an airplane and fly it straight into a Texan IRS building. [].

     It's hard to blame the bottomed-out debt addicts for expressing anger or even seeking revenge against the dealers or authority figures who worked to destroy their lives. The latter are especially contemptible when they constantly tell people to "stay away from drugs", but make it so damn easy for them to get some and even profit off of their addiction. Unfortunately, these institutions are the most inaccessible to the average addict, and so their fear and pain is more readily projected onto those that may actually care about them. There is, of course, the direct financial effect on the families of those who have been wiped out by a destructive debt addiction. The debt servicing costs of Americans consumed an all time high of ~14% of income in 2007, and these costs have had devastating effects on families whose incomes have continued to stagnate, decrease or have altogether disappeared. [3]. Families of the addicts may eventually lose their homes, cars and all the fancy things they have accumulated over years, returning to a state of frugal existence unexpected and long forgotten.

      It is also the case that there is a high correlation between drug abuse and domestic violence (61% of domestic violence offenders also report substance abuse problems) [4]. Could unserviceable debt be one of the destructive substances contributing to domestic violence in America? The National Domestic Violence Hotline reported a 21% increase in calls from September 2007 to September 2008, and 54% of these callers reported a change in their financial situation over the last year. Women in the lowest income category experienced six times the rate of nonfatal domestic violence than those in the highest category between 2001-2005, and women are three times as likely to experience domestic violence if their male partners have experienced two or more periods of unemployment over five years. Although there are obviously many factors that affect rates of domestic violence, financial instability certainly seems to undermine the psychological stability of male addicts and may lead them to express their sickness through violent  behavior. The Director of the Gender & Health Research Unit at South African Medical Research Council, Rachel Jewkes, has produced research suggesting that deteriorating finances leads men to feel that they have failed to live up to society's expectations of masculine success, and these men turn to misogyny, substance abuse and crime to fill the gap between expectations and reality. [5].

      Many drug addicts also vent their sickness by directing anger towards abstract groups of strangers around the world, since these groups are perceived as leading relatively "better" lives or posing an ephemeral threat to the addicts' chances of survival. After the attacks on 9/11, American addicts became enraged at a decentralized group of Muslim "terrorists", who had disrupted their comfortable existence at a time when they were just managing to "recover" from a debt-induced recession. The population expressed strong support for an invasion of Afghanistan and were also convinced by the Bush complex that Saddam Hussein's Iraq posed a major threat to national security. As these wars progressed and the American economy took off in another debt bubble, however, the comfortably numb addicts began questioning the wisdom of these wars, which were costing unconscionable amounts of lives and money. Between 2003 and 2005, public support for the Iraq war fell from 69% to 45%, and by 2006, 44% of addicts believed acts of terrorism were "not too likely" or "not at all likely" to occur in their communities over the "next several weeks". [6]. In stark contrast, during the ongoing debt deflation over the last year, the number of people who believed another terrorist attack is "very likely" to occur in the United States within the "next several months" increased by 14%, and "somewhat likely" over the "next several weeks" by 16%. [7]. Recently, some American addicts have also become incensed about a relatively harmless plan to build a Mosque near Ground Zero, as they increasingly feel threatened by the general Muslim population.

      Another large group of people targeted by American fiends has been the illegal Mexican population residing within the country. For many years, the flow of illegals from Mexico into American border states established a mutually beneficial geopolitical relationship, as the Mexican government kept social unrest in check and the economies of border states were supported by cheap labor and increased sales revenues. [8]. Now, many American addicts feel that the illegals are acting as a drag on the economy and sucking up unskilled jobs at a time when broad U-6 unemployment measures 17%. Studies show that public opinion on illegal immigration is more negative in states with relatively high unemployment rates. The border state of Arizona, facing massive pressure from addicts in a deflating economy, has decided to take matters into its own hands by giving local police significantly more discretion when stopping and questioning potential illegals. Polling data has shown that 60% of American addicts support this new law, even though the illegal population has actually dropped by almost 20% from 2007 to 2009. [9], [10]

     This piece has focused on the American people's debt addictions, but there are many other inter-related addictions at play now. We have all been addicted to high standards of living, large returns on investments, appreciating assets, government entitlements, cheap oil and imperial hegemony. All of these things forged a level of systemic trust and confidence that is now quickly evaporating along with the drugs that fueled it. American addicts had surely made beasts of themselves, getting rid of "the pain of being a man", but are now forced to deal with the sober reality that has stewed and festered in the previously dark corners of their lives. The politicians and pundits would like us to believe that we can restore our addictions and avoid the painful symptoms of withdrawal, but they are either ignorant of reality or lying and praying the addicts never figure out how sick they really are. Perhaps they are also blinded by their own addictions, as public debt burdens are becoming weighty and unmanageable. The individual debt addicts may be waving razor-sharp hunting knives in the societal eye, but then the strung-out government addicts are waving military hardware and atomic bombs. If Thompson were still alive today, he may have remarked that, with the right kind of eyes, we could stand on a steep hill and almost see the high water mark, where the wave finally broke and rolled back. One thing I know for sure is that I'm not going to turn my back on anyone, anytime soon.

**This piece is dedicated to the brilliantly insightful ideas and writings of Hunter S. Thompson:

"No explanation, no mix of words or music or memories can touch that sense of knowing that you were there and alive in that corner of time and the world. Whatever it meant ... "

Tuesday, October 5, 2010

Choice Architecture: Capitalizing on Competition

     Computer technology has increased in an exponential fashion throughout the last 50 years, whether it be in the form of laptops, cell phones, internet software, bluetooth devices or sensory equipment. Unlike technology involving advanced weaponry or biological manipulation, new computerized devices are almost always welcomed with open arms by the American public, and have not posed many ethical issues (except perhaps in the context of law enforcement). Of course, that doesn't mean there has not been a good deal of concern about its uses voiced by academics and writers. The words written by George Orwell in his seminal work 1984 [1], in which the government used advanced technology to monitor and control its citizens, should have perhaps been regarded as emerging facts rather than imaginative fiction. The internet, for example, has proved to be an excellent data-mining source for governments and corporate institutions that seek to gain information about their citizens and customers, and this reality should be cause for a lot of concern. Check out this video entitled the "Most Disturbing Presentation Ever: Our Tech Nightmare", which presents a new form of computerized commercial technology which may easily cross the line of clever corporate gimmicks, and enter the realm of unethical social manipulation:

     Indeed, the presentation does illustrate a harrowing picture of advanced technology in the hands of large retail corporations. American companies constantly strive to manufacture new consumer "needs" through psychosocial manipulation (a.k.a. marketing and adverting), since production capacity generally exceeds the existing market's ability to absorb it. What better way to achieve this goal than exploit the competitive "gamer" culture that has evolved in American society? The last two decades have seen an explosion in the proliferation of video game consoles, computer games, competitive reality shows, game shows, casino rewards programs and various point systems in general. Americans obviously spend a great deal of time and money watching sporting events, and many sports bars actually have trivia or poker games for people to play while they watch a game. If Kellogg's can successfully convert something as simple as eating cereal into an interactive competition, then it can guide its existing customers towards consuming more of its products and also capture new customers who would have otherwise abstained from consumption.

    The presentation makes some very good points, but unfortunately it tends to lump every form of technologically-based social manipulation under the same label of "disturbing stuff". The presenter quickly mentions that governments could use a competitive point system to encourage the use of public transportation, and leaves us with the implication that this may be an undesirable outcome. Perhaps the more times an individual puts money on a metro card and uses it, the more instant points are accumulated on that person's "environmentally-friendly scoreboard". At the end of the year, an individual's points can be translated into a tax credit for a portion of the money spent that year, and special prizes could be given to "players" who score in the top 5%. This example should not be glossed over as another degrading intrusion of people's privacy, or unethical form of manipulation, because it actually reveals an important function that our governing institutions could perform. Our modern society has been characterized by an increasingly large federal government that creates more and more regulatory mandates and bureaucracy to address real or perceived problems. This process has led to enormous amounts of waste, misguided dependence, unintended consequences and a general loss of freedom, but that doesn't mean our governments have no role to play in formulating public policy.

     The field of behavioral economics analyzes the economic decisions of agents within a complex society using social, cognitive and emotional factors. Two prominent writers in this field are Richard Thaler and Cass Sunstein, who produced a book in 2008 entitled Nudge [2], in which they question the mainstream view (mainly of neoclassical economists) that people make economic decisions in a rational, self-interested manner. They clearly show that people respond to subtle environmental cues when making decisions, whether it's a  relatively harmless choice about what magazines to buy or the more serious choice of which retirement plan to choose from an employer. In our complex society that presents dozens of choices to be made on a daily basis, many of these cues are not accidental but have evolved as a part of carefully designed structures, which Thaler and Sunstein  term "choice architecture":
"Choice architecture is the context in which you make your choice. Suppose you go into a cafeteria. What do you see first, the salad bar or the burger and fries stand? Where's the chocolate cake? Where's the fruit? These features influence what you will choose to eat, so the person who decides how to display the food is the choice architect of the cafeteria. All of our choices are similarly influenced by choice architects. The architecture includes rules deciding what happens if you do nothing; what's said and what isn't said; what you see and what you don't. Doctors, employers, credit card companies, banks, and even parents are choice architects." [From Amazon Interview]

     In an American economy where 70% of the GDP is comprised of consumer activity [3], it's unsurprising that the most influential choice architects are corporations. American corporations collectively spend billions of dollars every year on market research (focus groups, public opinion surveys, psychological studies, statistical analysis, etc.) to construct the choice architecture that best aids them in selling their goods and services. The incorporation of advanced sensory technology into products, for the purpose of creating competitive consumption games, would establish a significantly more dominant architecture than we already have. Although it seems unlikely that corporations will be able to financially justify the costs of widespread implementation of this technology during an economic depression, in which the wealth of consumers' is being rapidly destroyed, they may still find limited ways to exploit it. Either way, why should private corporations  get all of the benefits from the latest research in computer technology and behavioral economics? Now is a better time than ever for the people, through their local representatives, to utilize modern scientific insights into guiding economic decisions in a complex society.

      To be effective and avoid counter-productive consequences, I strongly believe that most implementation of choice architecture must be done at the local or state level.  Unlike the federal government, localized governments can more appropriately tailor policies for their specific populations and implement these policies without too much waste or corruption. The federal government may be able to take a passive role and help fund research for state initiatives, but the process of formulating and implementation should be largely left to localized institutions. It may seem counter-intuitive that smaller governments are less likely to be captured by corporate interests, but the decreased size and complexity is exactly what limits corruption. The daily actions of local representatives are more visible than those of their federal counterparts, and they have to live and work among their constituents. There has certainly been some corrupt dealing by local and state officials in the past, but it's less likely these officials will be willing to cross their distrustful populations in the near future.

     When it comes to the imminently desirable goals of protecting environmental, ecological and biological systems from climate change and promoting the development of mass transit, the public may need more than just a small nudge. The competitive point system mentioned above, which gives significant tax breaks to individuals using public transportation, would more appropriately be considered financial coercion by the state. The power to tax, after all, is the power to destroy, and the same could be said of the power to give tax breaks (the power to destroy the competition). Still, our society is at the point where there's no more time left to procrastinate, and individuals should be significantly rewarded when they sacrifice convenient transportation to help create a more healthy environment for current and future generations. A choice architecture built into the tax code may be the most influential means of accomplishing these goals, short of creating strict, mandated limits on people's carbon footprints. The latter would not only be politically unfeasible, but would also create additional bureaucracy, unintended consequences and resentment in our society. Perhaps state governments could also display fancy television and billboard advertisements for their new mass transit competitions, similar to those that car companies bombard us with every day.

     There are many other areas in which a carefully designed choice architecture could nudge our society to beneficial results, without requiring signficant financial incentives. Of course, we must first establish what is "good" for society, because definitions will vary based on the definer's worldview and expectations for the future. Personally, I believe the best thing our leaders can do at this point is promote localized resilience and passively manage a transition to reduced complexity in our societal structures. This goal would  include helping people become less dependent on government handouts or the products of multinational corporations to survive and have a decent existence. As a subset of resilience, people should be encouraged to produce their own food, maintain good health, consume less energy and preserve their wealth without exposing themselves to huge risks. Therefore, the following examples of competitive choice architecture (with or without a technological twist) will primarily focus on the areas of food production/consumption, energy use and financial decisions.

Food Production and Consumption

     A crucial element of local resilience is the ability of people within a community to produce their own food. A volunteer group in Peru called San Francisco Saludable is currently working with community members to transform waste products into compost for gardens. Citizens are encouraged to submit their recyclables to the group, which transforms them into compost and delivers it back to the community free of charge. [4]. Local governments in America could institiute a similar program and encourage their citizens to take full advantage of it. Participating members could be rewarded with points based on the amount of compost created from their submitted waste, and also gain bonus points for using that compost to grow a vegetable garden. It would certainly be a cheap, efficient process for members of the community, and could create enthusiasm and a sense of pride for the people who use their garbage to grow their own food. The "waste-to-compost players" who contribute the most to local food resilience could receive recognition for their efforts in the local media.

     Many local communities across the country rely on several mega-lithic grocery stores to provide their citizens with food, and it can become an extremely complex process for shoppers to pick out healthy and/or environmentally-friendly items. These communities could borrow an idea from institutions in the UK, Japan and France, where certain producers and retailers are placing "carbon footprint labels" on food items. [5]. These labels provide a simple, uniform way for people to determine exactly how energy-intensive the items were to produce and distribute. Maybe a degree of health consideration could also be included by making the label green (healthy) or red (unhealthy) based on an established local standard that is familiar to residents of the area. The communities could also utilize computerized reporting technology that would allow residents to compete for the lowest carbon footprint, and give some of the highest scores (proportionately inverse to the carbon footprint) a mention in the local paper. The informative labels and friendly competition would help nudge consumers towards purchasing items that are better for their environment and their health.

      The Department of Health in New York recently conducted research on how to increase sales of fruits in school cafeterias. While the government primarily focused on price, the actual researcher decided to be a bit more creative and focus on choice architecture. After noticing that several schools placed their fruits in steel bins in dimly-lighted areas of the lunch line, he purchased a cheap fruit rack and a lamp to shine on the fruits. The sales of fruits in this school went up 54% after two weeks of implementing the new architecture. [6]. Here we have a great example of a simple, cheap modification that could encourage healthy meals in school districts across the country. Of course, we could always increase the nudge effect by giving the students an electronic scorecard that racks up points whenever they purchase fruits and/or vegetables. The points leaderboard could be displayed on a screen in the cafeteria and be updated each day. At the end of each school week, the student with the most points gets a small prize... and possibly a decreased chance of congestive heart failure in the future. Any student who gets caught cheating by purchasing fruits and dumping them is disqualified for the entire month, and also gets a weekend in detention!  

Energy Use

     There has already been a lot of buzz about communities and utility companies across the country using "smart meters" and "smart grids" to gather daily data about energy use, report it back to households or even communicate the data to "smart appliances", which adjust their settings accordingly. Much of this technology is expensive to develop and install, however, and may be coming to fruition at a time when communities and consumers are least able to afford it. A Virginia company called OPower has decided to focus on a much simpler and cheaper way of promoting energy conservation, by combining the lessons of behavioral economics with some neighborly competition. The company develops monthly energy reports for a household that compares it's energy use with that of its neighboring homes, makes suggestions about how to improve energy efficiency and, last but not least, places smiley faces on the reports of those households which have used less energy than the prior month. OPower found that more than 75% of the households receiving these reports did something to reduce their energy use in the future. [7]. Many American communities could require their utility companies to provide these types of reports, and they could also combine the smiley faces with a scoreboard that would be available for all members of the community to see (provided that the household consents to disclosure).

     A more technological nudge could be provided by obtaining energy use data from "real-time monitors" and posting it to a public website. The U.K. government has implemented this great idea for energy conservation by monitoring real-time energy use of all government departments and posting the data to a wesbite that can be accessed by the public. This incentivizes the departments to "practice what they preach" in terms of energy efficiency, since they can be held publicly accountable for wasted energy, and helps address the problems of both excessive public debt and accelerating climate change. [8]. The relatively affluent communities in America may be able to institute a similar program, where citizens who choose to participate will have their energy use monitored in real-time and published on a public website. A public display of energy use and a little competition can go a long way towards saving people money, making them less dependent on external sources of energy and helping to maintain the environment everyone must live in.

     A Spanish architect and design lecturer, Uriel Fogue, presents an interesting nudge in the area of energy resilience. He designed a workshop for students in which they had to initially contribute $15 to a pool, and each day they would bet a portion of that money on their ability to answer questions about solar arrays. The student with the most correct answers at the end of each day would win the collected money. This "energy bets" workshop led to an increasing amount of correct answers, and increasing accuracy, as the days progressed. [9]. Local governments could implement a similar betting scheme for participating residents that focuses on increasing knowledge about the technical and financial aspects of coverting to solar-generated electricity. Each player could contribute a relatively small sum to the community pool and log onto a website each day to answer detailed questions about solar technology. At the end of the month, the entire pool can be divided between a few players with the most correct answers, and perhaps the winner will receive free installation of solar panels on his/her home.

Financial Decisions

     The tendency of people to enjoy gambling and their cognitive bias towards overestimating the probabilities of rare events are typically bad things at a craps table, but could be used to create a very useful nudge in local communities or states. A fundamental factor that has contributed to the unsustainable nature of the American economic system is the choice architecture which has incentivized excessive consumption and low savings. A Harvard professor named Peter Tufano recently designed a program called "Save to Win", operating in Michigan, which enters people into a monthly lottery if they invest a minimum of $25 into a certificate of deposit. The CDs earn less than average interest (1-1.5%), but offer savers the opportunity to win $400 each month and $100,000 each year. [10]. Other states and communities could implement a similar "CD-lottery" program administered by not-for-profit credit unions, and savers could receive points for referring others to the program. Those people with the most points each month could be given an extra "ticket" to the big annual prize.

     Richard Thaler wrote an article in the New York Times this year exploring the reasons why so many people continue to make payments on mortgages that are significantly "underwater" (outstanding debt obligation is more than the home is worth), despite it being against their financial interests. One factor is that people feel a moral obligation to "honor" their debt contracts, thanks to the propaganda of bankers and politicians who helped place them in this precarious situation. [11]. Businesses frequently commit "efficient breaches" of their contracts when the liability cost of doing so is outweighed by the benefits of getting out from under future obligations, and they would give you a very strange look if you told them these breaches were unethical. The moral obligation argument is especially weak in states with non-recourse mortgages, where homeowners initially have to pay more for the benefit of the loan being secured only by the home, so that banks cannot go after any other assets in the event of default. [12]. Communities in non-recourse states, or the states themselves, could require their banks to explain the concept of "efficient breach" on mortgage documents to their customers. They could also use flyers and television advertisements to reinforce the message and present some options for homeowners who wish to proceed with default (local apartments to rent, legal aid offices to consult, etc.). No competition here, just a small nudge.

Households in Negative Equity or Near Negative Equity by State

     Another interesting nudge towards a debt-free existence is a "net worth monitor", proposed by a former financial adviser named Julia Thompson. She proposes that financial institutions implement this monitor on their websites, allowing customers to dynamically link to all of their asset balances and oustanding loan balances, using Kelley Blue Book value for their cars and Zillow estimates for their homes. Tax-deferred retirement accounts could also be included, but the site would advise people against doing so since these accounts are usually not appropriate for paying down debt. The monitor would instantly calculate a person's net worth, update the number each time the person logs on and also provide a "thermometer-type chart" showing red (negative net worth) or green (positive net worth). [13]. Taking this idea a step further, states could require financial institutions and brokerage firms that serve their citizens to allow the customers to link to their accounts on a website run by the state government. All of the customer's accounts would be on a single page that updates in real-time, and the customers could be rewarded points based on how much debt they pay down as a percentage of their assets. Although there may be a few cases in which assets should be maintained rather than used to pay off debt, on the whole this competitive nudge will prove to be useful in the current deflationary economy.


     The field of behavioral economics is not as straightforward as it may seem, especially in our complex global economy, so some of the nudges described above will be more successful than others. Every state or community should perform adequate investigation and experimentation before implementing choice architectures. It is also true that the competitive nudges through advanced computerized technology may simply be financially impractical for many communities to implement. Still, our state and local governments need to seriously consider the numerous ways in which they can passively guide their citizens towards increased resilience. There are currently too many people who rely on the federal government to simply get by from day-to-day in this economy, and this dependence has atrophied their ability to make any meaningful changes. Many people may view nudges by local institutions as just another form of psychosocial manipulation by a centralized authority, and they would be largely correct. However, we must realize that our complex socioeconomic structures will lead to a certain amount of manipulation no matter what. Human beings should embrace the fact that they are not rational, coldly-calculating creatures, at least not in every context, and should welcome some guidance in their lives. At the end of the day, the government will not be threatening anyone with physical or financial punishment for failing to participate, and the people will still have the opportunity and freedom to make the decisions they feel are best.