Arbitrary Power

Freedom of Men under Government is, to have a standing Rule to live by, common to every one of that Society, and made by the Legislative Power erected in it; a Liberty to follow my own Will in all things, where the Rule prescribes not; and not to be subject to the inconstant, uncertain, unknown, Arbitrary Will of another Man: as Freedom of Nature is, to be under no other restraint but the Law of Nature.

Second Treatise of Government, by John Locke (1689)

This ornamental sign lies a couple miles south of my house.

It is not a thing that anyone takes very seriously, not because there’s anything unusual about where I live, but because there isn’t anything unusual about where I live. Every city in North America east of the Rockies maintains a cringeworthy “if you don’t like the weather here today, just wait until tomorrow” joke culture on account of the basic traits of our ubiquitous humid continental and humid sub-tropical climate types. So, too, do each of those same locations maintain some local lore about how bad drivers are in this location or that, suspending disbelief at the superficial silliness of the claim.

I’ve lived in Chicago, Philadelphia, Houston, Dallas, Austin, New York, Germany and now the wilds of Connecticut. Drivers are mostly the same, and what’s more, on a road with particular qualities – its width, its outlets, its proximity to towns, homes and the like – most drivers intuitively drive about the same speed. The difference isn’t the drivers.

It’s the rules.

If you picked up this road and everything about it – the surroundings, the level of traffic, the neighboring roads and communities – and put it in rural Texas, I feel very confident that the average speed driven would be about the same as it is here. Call it 40 miles per hour, give or take. But instead of having the number 25 written on this curiosity of a sign, however, it would have the number 35. That’s not to say that some drivers don’t attenuate their speed to some function of the posted speed limit, of course, but that’s part of what I’m getting at here.

Practically nobody wants to live in a system of extremely restrictive rules enforced in a rigid, inflexible manner. Practically nobody wants to live in a system with few laws and indifference toward the enforcement of the ones that do exist. There are two alternatives, and they form many of our social disagreements: do we create a system of firm laws but vest powers of judgment and fairness in officials to relax them where needed or do we create a system of limited laws which we can expect to be strictly enforced? These two approaches lead to different behaviors by the governor and the governed. They also lead to different kinds of asymmetric risk, even if the average outcome is the same.

I know where I come out on this one:

Forget about the broad social and political implications for a moment. After all, this is just basic rule-of-law stuff. It isn’t just an important question for our relationship with our government. It’s an important question for our relationship with our own processes, and an important component of the way we manage our own behaviors as human beings, civilians and investors. We make choices on this dimension all the time:

  • When we diet or abstain from some kind of activity or food, we can set a range of targets and limitations, but give ourselves flexibility in whether we cheat on those rules. Or we can set a much more limited set of rules but interpret them strictly.
  • When we set guidelines for our children, we can create a maze of rules and expectations onto which we layer occasional acts of mercy. Or we can be more permissive in our rules. We can allow failure. And ruthlessly enforce a much more limited set of core values and safety-related rules.
  • When we build portfolios, we can constrain them to a firm, definitive framework of our understanding of financial markets, and then override whenever it seems like it may not be capturing something that worries us. Or we can be parsimonious in what we incorporate into our models, yet permit ourselves much less in the way of discretion over their interpretation.

In the same way that so many people who hear ‘rule of law’ still, for some reason, think it means ‘more rules and police’, many who hear ‘process-driven’ or ‘rules-based’ often think that this is a call for ‘more rules.’

It isn’t. Or at least, it shouldn’t be.

As we have written, part of the investment meaning behind Clear Eyes and Full Hearts is to act boldly on our beliefs while holding loosely to them. It is not strictly a paradox, but at least fascinating to note that we do this best when the processes we design to implement those beliefs reflect nearly the reverse: limited in scope yet rigid in application. If the reason isn’t immediately clear, it is this: if you incorporate a willingness to hold loosely to your beliefs, you must increase your certainty that your processes will tell you when it’s time to adjust them. If you permit yourself to insert judgment at every stage of your investments, from principles, to philosophy, to process, to implementation, you will end up being subject to arbitrary power.

Not from a government, or a judge, or a traffic cop. From your own mind.

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  1. Our present-day problem is that our regulatory state has grown - as most regulatory states will as doing so increases their power over the governed - to the “many laws inconsistently and arbitrarily enforced” model, which leaves the law-abiding always uncertain and the devious (or, in ET-speak, the raccoons) seeing opportunities.

    An honest trader or money manager on Wall Street - one who deeply and sincerely wants to play by the rules - can only guess at where the lines are drawn, how rules and regs will be interpreted and where “safe harbors” really exist. And worse, to be competitive with the raccoons - to keep ones business or career going - one is pushed further into the grey or he or she will fail.

    As a very smart FA - who appeared to me to be sincere in wanting to do the right thing by his clients - told me years ago, “if I had the risk disclosure conversations with my clients that the regulators and our compliance area want me to have, I’d have no clients as they’d all leave me for FAs who wouldn’t have those conversations.” He wasn’t saying he lied or didn’t want to tell the clients about risks - he did - he just knew that if he played by the “safe harbor” approach, all he’d do is end his career and, probably, leave his clients less informed.

    And this doesn’t even address the horrible “gotcha” game when a regulatory body allows, for years, certain grey behavior, so it becomes an industry norm (common knowledge in the game theory definition) to only arbitrarily decide one day to enforce the rule against that behavior and it starts arresting or fining advisors and firms for what had been tacitly acceptable behavior.

    Last thought, as someone who was a line-of-business risk manager (you do your LOB day job while compliance dumps a bunch of additional compliance responsibilities on you that your boss doesn’t want to do him/herself and that compliance wants to be able to blame you for not properly policing if a problem is found later), I quickly realized that almost anyone with real responsibility on Wall Street could be found guilty of a rule or reg violation if the regulators wanted to do so.

    That’s a very long way of saying I’m for fewer laws clearly and consistently enforced because, yes as you note, it increases your freedom, in part, because it reduces the arbitrary power of the state.

  2. Interesting that you have chosen to live in Connecticut(as have I). This state is well down the path to far too many rules and taxes and clearly headed further in that direction - unless something changes very soon…

    The problem stems from the fact that once the government grants a benefit - let’s say healthcare for example; it becomes the public’s business what you eat and drink or what you smoke, because those choices cost other people money.

  3. As a healthcare provider, I am confident that a massive amount of rhetoric will be composed about Healthcare these next few years. As to the point about choices costing money, it works both ways. Are you sure smoking costs more? Sudden dealth is very inexpensive and prevents a multitude of future patient ‘touch’ visits and preventative care, not to mention all those future ortho problems and long term care with end-of-life costs still waiting in the wings. Meanwhile, everybody in the ‘business’ knows the big money is in preventing diseases that don’t exist rather than treating the ones that do. You can be sure that Medicare for All will be spun as Socialized Medicine and Medicare with Limits as ‘Death Squads’. The widening gyre virtually guarantees that the Healthcare conundrum will not be ‘fixed’. Putting Big Pharma, Insurance, Academia, and corporate providers together with politicians and the state will never work. How Big Tech managed to get into the room is a tribute to their persuasion. Next time you hear the quality-of-care mantra, especially with comparative effectiveness, think of what ET authors write about portfolio manager analysis. Then take kaopectate!

  4. Excellent point on the relative costs of medicine - which somehow don’t enter the debate. thanks for the insight.

  5. Avatar for bobk71 bobk71 says:

    Thanks for the insight and the story. The incentives to do ‘bad’ things are everywhere in this system. Labs are encouraged to dream up new products regardless of their impact on the environment. Savers are encouraged to invest in the labs and other risky ventures by being left with no erosion-free storage for their savings. This is not to mention finance!

    The key for the top elites is to create demand for the money and debt they issue. Called ‘growth,’ this demand is the only long-term way to stabilize the system they have destabilized by issuing the paper ‘wealth.’ ‘Growth at all cost’ is the only religion subscribed by all major political candidates.

  6. Avatar for rguinn rguinn says:

    The nature of the Leviathan, unfortunately, and the problem with any kind of central planning. There is always some related human activity which must come under centralized power in order to facilitate another.

  7. Avatar for rguinn rguinn says:

    Amen, Mark. If I ever slept poorly managing an investment firm, it was from fear of caprice on the part of gatekeepers and regulators. And that’s not an accidental state of affairs. It’s a wholly intentional part of the design of every compliance program in the world: not protection of the interests of fiduciary charges, but fear.

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