What is an Idea Worth?

Applying Philosophy to Business (and vice-versa)

This guest post is by a PhD student in philosophy from the Australian National University.

DEATH AND TAXES, the adage goes, are life’s two certainties. One might add commerce and philosophy to this list, for the trade of goods and services and the trade of ideas also seem to emerge everywhere that people do. Enterprising governments found a way to combine the expiration of citizens with the raising of revenue – and gave us death duties. So let us ask: what is the relationship between business and philosophy?

The fundamental requirement for commerce – or so it seems to me – is that participants and regulators agree that there is some notion of property rights which underlies the doing of business. Only if property rights are acknowledged by participants are the ideas of buying and selling coherent; only if the law protects property rights and regulators enforce them can the system work in practice.

Of course, developing a theory of property rights is something which has occupied philosophers for centuries. Broadly, the concern has been to understand what it is that gives someone a right to possess or control something to the exclusion of all others. Is there some special, intrinsic connection between a person and an object owned? Or is it merely agreed between people that one should not interfere with something owned by another?

Centuries of discussion notwithstanding, there is no consensus as to which, if any, of many theories regarding the above issues is the best. This is not without practical implications. The ideas about property which prevail in the community and in our politics feed directly into the laws and regulations which we have about property ownership and about doing business. Given the failure of philosophers to articulate definitively the nature of property, then, and given the reliance of commerce on property rights, it may be worth pondering exactly what, if anything, an ideal theory of property rights should be worth to a businessperson. A simple thought experiment will help with this.

Imagine that you are in business supplying widgets but that your only competitor in the widget supplying business is performing significantly better than you. Imagine that someone in your community announces that they have access to a perfect and absolutely infallible theory of property rights and that you have reason to believe that this person does in fact have access to such a theory (it does not matter how they got access to this theory – philosophical genius, divine inspiration, accident, whatever). Imagine also that this theory is for sale to either you or your competitor: for appropriate consideration, this (perhaps opportunistic) citizen will give to the buyer (and to the buyer alone) access to the theory.

Why would either of you want access to the theory? Assume that, once in possession of the theory, the buyer will be able to make a decision about the legal situation in the community. If the buyer (and now de facto legislator) wishes, the laws which govern property rights in the community will be made to conform to this (by hypothesis) ideal theory of property rights. Obviously, the buyer would choose this option if doing so would give his or her business an advantage as against the competitor. Otherwise, the buyer could simply leave the legal situation as it is.

What to do? How much would you be prepared to pay for access to the theory? If we had some more information about the extent to which your business is outperformed by its competitor and the expected outcome of altering the legal system, then it would be possible to calculate the best course of action. This, however, is not really the point of the thought experiment. What is striking is that, as a businessperson, you rely on there being a legal regime based on some vague ideas about property. It may or may not be in your interests, however, for this legal regime to reflect the best possible ideas about property – this may or may not give you an advantage. Regardless of how you would be inclined to act, the fact that the thought experiment is intelligible proves this point. We are able to conceive of something as abstract as the sale of access to a theory of property rights even though, on the terms of the thought experiment (and in reality), we are thinking about the matter only with the aid of the imperfect theories of property rights which we do have.

As for one businessperson, so for the business community. In order for business to work, there needs to be a legal regime which gives expression to some vague notion of property. It is not necessarily the case, however, that a legal regime which gives expression to the best possible theory of property would be the best regime for business and for the economy.

This is not a reason to give up thinking about property. Ideas about property are important to individual security, to social welfare and to our interactions with government and we might want to continue exploring the concept because we are concerned about these issues. Alternatively, it may work just as well in these contexts if we proceed on the basis that some undefined notion of property underlies our dealings.

Perhaps the point demonstrated by the thought experiment – that we do not all need to subscribe to the same, let alone the best, theory of property in order to do business – is just common sense. Philosophers spend a lot of time trying to prove results which do seem obvious; for sometimes the proof is much less obvious that the result. If the idea demonstrated by the thought experiment is in any way instructive, it may be because it borrows the currency of business and asks what a particular type of theory would be worth to those to whom it is perhaps most relevant. That is, it investigates the value of a theory. There is a nice symmetry here. Business takes as assumed certain philosophical ideas about property; philosophy can perhaps better illuminate the notion of property by borrowing the method of business.

BASEL III for dummies

An explanation of Basel III for non-specialists

BNP Paribas Fortis provides a short 10 minute animated presentation on Basel III.

For normal people like you and I, this is a nice, accessible and informative summary of how the Basel III framework actually works.

Can we rely on LIBOR?

Society has lost its trust in the financial sector. Should we overhaul LIBOR?

IN A RECENT article by Bloomberg Businessweek, assistant managing editor Brian Bremmer reports that investigators in America, Canada, Japan, the UK, and the EU are trying to determine whether a handful of brokers and traders have manipulated LIBOR.

At this stage, it is unclear whether the investigations will uncover any wrongdoing, and Bremmer notes that no banks or individuals have actually been charged.

If banks have engaged in collusive behaviour to manipulate LIBOR, then this is a serious cause for concern.  Bremmer highlights the importance of LIBOR by explaining that it is “a key benchmark rate that affects the price of $350 trillion worth of securities and loans around the world.” Indeed, the British Banker’s Association notes that LIBOR “is the primary benchmark for short term interest rates globally. It is written into standard derivative and loan documentation such as the ISDA terms, and is used for an increasing range of retail products.” To drive the message home, Bremmer notes that this “may include your car loan or even your home mortgage.”

UK regulators and global banks are discussing an overhaul of the calculation and regulation of LIBOR, which is currently set by a small group of financial professionals with little regulatory oversight.  How concerned should we actually be?

On first glance the lack of regulation sounds worrying, however there does not appear to be any real cause for concern.

The current method of calculating LIBOR appears to be robust and reasonable, and here are three reasons why.

1. The LIBOR calculation

LIBOR, the “London InterBank Offered Rate”, is a benchmark which indicates the average rate at which leading banks can obtain unsecured funding in the London interbank market. LIBOR is published by Thompson Reuters each business day for 10 different currencies with 15 maturities for each currency (i.e. 150 rates in total).

The rates for each currency are determined by a panel of up to 18 contributing banks, which submit their rates to Thomson Reuters between 11.00am and 11.10am each business day. After it receives submissions, Thomson Reuters then calculates LIBOR by using a trimmed arithmetic mean. It ranks each submission in descending order and excludes the highest and lowest 25%. It then takes the arithmetic mean of the remaining contributions to determine LIBOR.

This method of calculating LIBOR appears to be reasonable because LIBOR is intended to indicate the rate at which banks can obtain unsecured short-term funding in the London market.  It is not clear whether there is anyone better placed to determine this rate than a panel of up to 18 leading banks. Banks outside the UK currently use LIBOR in loan documents to estimate their cost of funding because London is a key financial centre and LIBOR is typically a reliable benchmark. If a bank’s cost of funding changes dramatically in the short term, it is normally able to rely a “market disruption” clause to adjust rates upwards.

2. Bank bias

Some commentators have criticised LIBOR by arguing that individual banks may have a commercial incentive to over or under-state the rate it submits to Thomson Reuters.  This is true.  Individual banks may have commercial incentives to over or under-state their cost of funding.  However, this is not a reason to overhaul LIBOR. Rather, LIBOR is designed to deal with bias from banks because of the way it is calculated.

When banks submit rates to Thomson Reuters, the highest or lowest rates are excluded. This means that a bank which is biased (and reports an unrealistically high or low rate) will not affect the actual LIBOR calculation. The British Banker’s Association notes that “[t]he decision to trim the bottom and top quartiles in the calculation was taken to exclude outliers from the final calculation. By doing this, it is out of the control of any individual panel contributor to influence the calculation and affect the [LIBOR] quote.”

After the outliers are trimmed, LIBOR is calculated by taking the average of the remaining rates. Although a bank may have a commercial incentive to slightly over or under-state its cost of funding, different banks will typically have different incentives because they have different trading positions. As a result, the averaging process further reduces the effect of individual bank bias.

3. Trust is the basis of social institutions

This may be the crux of the issue.

While the LIBOR calculation appears reasonable and helps to correct for a certain amount of reporting bias by individual banks, there is nevertheless a strong dissatisfaction with the financial sector.

The global financial crisis of 2008 was caused by an act of deception (or rather, many acts of deception). Wall Street investment banks worked financial magic by turning large numbers of sub-prime mortgages into AAA-rated mortgage backed securities. To understand the extent of the fraud, this is the equivalent of a used car salesman taking a worthless car, painting over the rust, winding back the odometer, and then selling it for 10 times its true value. And then doing this again, a billion times.

As a result, society has lost its trust in bankers and the banks they work for. And this trust will take years to rebuild.

Society has lost its trust in the financial sector, but does this justify overhauling LIBOR?

If you have an opinion, please comment below.